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Long-term fiscal sustainability... -- Sandra Batten, United Kingdom

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This presentation was made by Sandra Batten, United Kingdom, at the Introductory Workshop on Green Budgeting Tools held at the OECD, Paris, on 29 April 2019

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Long-term fiscal sustainability... -- Sandra Batten, United Kingdom

  1. 1. Climate change, economic risks and fiscal sustainability Sandra Batten Bank of England Paris Collaborative on Green Budgeting – 2nd Green Budgeting Experts Meeting OECD, Paris 29 April 2019
  2. 2. Any views expressed are solely those of the presenter and cannot be taken to represent those of the Bank of England or to state Bank of England policy. This presentation should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Authority Board. Sandra Batten
  3. 3. Outline • Definition of climate change risks • Framework for transmission channels of climate change risks to the macro-economy • Macroeconomic effects • Implications for fiscal sustainability Sandra Batten
  4. 4. Climate change risks Sandra Batten
  5. 5. Macroeconomic risks from climate change Two types of risks (BoE 2015; Carney 2015; Batten et al. 2016): 1. Physical risks: Risks that arise from climate-related hazards 2. Transition risks: Risks of economic dislocation and financial losses associated with the transition to a lower-carbon economy Sandra Batten
  6. 6. Types of physical risks 1. gradual global warming and associated physical changes, for instance in total seasonal rainfall and sea level; 2. extreme weather events (e.g. heat waves, storm surges, high precipitation), including their increased frequency, severity and correlation (Stott 2016; AMS 2018). Sandra Batten
  7. 7. Time GDP Level effect Growth effect ΔT>0 Global warming: Level vs growth effects of temperature on GDP
  8. 8. Time GDP Climate event “Creative destruction” “Recovery to trend” “No recovery” Possible economic effect of climate related disasters
  9. 9. Transition risks: trade off between growth and emissions Policies to reduce energy intensity: • Carbon price • Other indirect taxation • Subsidies for energy efficiency Sandra Batten 𝐶𝑂2 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 = 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 × 𝐺𝐷𝑃 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 × 𝐸𝑛𝑒𝑟𝑔𝑦 𝐺𝐷𝑃 × 𝐶𝑂2 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠 𝐸𝑛𝑒𝑟𝑔𝑦 Energy intensity of GDP Carbon intensity of energy Policies to reduce carbon intensity: • Carbon price • Subsidies for low carbon energy innovation • Regulation
  10. 10. Framework for macroeconomic impacts of climate change Sandra Batten
  11. 11. Macroeconomic effects of climate change • Aggregate supply: 𝑌 = 𝐴𝐹 𝐾, 𝐿 • Standard climate damage representation: 𝑌 = 𝐷(∆𝑇)𝐴𝐹 𝐾, 𝐿 Sandra Batten
  12. 12. Integrated assessment models (IAMs) Economic dynamics Carbon emissions Carbon concentration Climate impacts (climate sensitivity) Economic impacts (Damage or loss function) Abatement costs Economic module Climate module Sandra Batten
  13. 13. Demand side effects and fiscal implications • Aggregate demand: 𝑌 = 𝐶 𝑌 − 𝑇 + 𝐼 + 𝐺 + 𝑁𝑋 • Government: 𝑏𝑢𝑑𝑔𝑒𝑡 𝑑𝑒𝑓𝑖𝑐𝑖𝑡 = 𝐺 − 𝑇 = 𝐺 − 𝜏𝑌 Sandra Batten
  14. 14. Macroeconomic impacts of climate change Sandra Batten
  15. 15. Economic framework to assessing economic damage from climate change Examine different channels for each type of risk and the likely timing of effects (Batten 2018). Sandra Batten Type of risk Economic outcome Timing of effects Physical risks from: Extreme climate events Unanticipated shocks to components of demand and supply Short to medium run Global warming Impact on potential productive capacity and economic growth Medium to long run Transition risks Demand/supply shocks or economic growth effects Short to medium run
  16. 16. Demand side effects of climate change risks Sandra Batten Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Demand component Investment Consumption Trade Government budget
  17. 17. Demand side effects of climate change risks Sandra Batten Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Demand component Investment Uncertainty about climate events Consumption Decrease in household wealth due to increased risk of flooding to residential property Trade Disruption to trade flows due to natural disasters Government budget Diversion of resources from public services to emergency and reconstruction
  18. 18. Demand side effects of climate change risks Sandra Batten Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Demand component Investment Uncertainty about climate events Uncertainty about future demand and climate risks Consumption Decrease in household wealth due to increased risk of flooding to residential property Changes in consumption patterns, e.g. more savings for hard times Trade Disruption to trade flows due to natural disasters Changes in trade patterns due to changes in transport systems and economic activity Government budget Diversion of resources from public services to emergency and reconstruction Diversion of resources from public investment to climate adaptation and mitigation
  19. 19. Demand side effects of climate change risks Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Demand component Investment Uncertainty about climate events Uncertainty about future demand and climate risks ‘Crowding out’ from climate policies Consumption Decrease in household wealth due to increased risk of flooding to residential property Changes in consumption patterns, e.g. more savings for hard times ‘Crowding out’ from climate policies Trade Disruption to trade flows due to natural disasters Changes in trade patterns due to changes in transport systems and economic activity Distortions from asymmetric climate policies Government budget Diversion of resources from public services to emergency and reconstruction Diversion of resources from public investment to climate adaptation and mitigation Inefficient climate policy Sandra Batten
  20. 20. Examples of direct impacts of climate change risks on government budget • From extreme climate events – Damage to public infrastructure: transport systems, public buildings, energy and telecommunication networks • From global warming: – More frequent replacement of physical and infrastructure capital – Adaptation expenditure: cooling systems, flood barriers • From transition risks: – Distortionary carbon tax and other taxations – Negative re-distributional effects …but also indirect effects through Y and reduced taxation! Sandra Batten
  21. 21. Supply side effects of climate change Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Supply component Labour supply Energy, food and other inputs Physical capital stock Technology Sandra Batten
  22. 22. Supply side effects of climate change Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Supply component Labour supply Loss of hours worked due to natural disasters Energy, food and other inputs Food and other input shortages Capital stock Damage due to extreme weather Technology Diversion of resources from innovation to reconstruction and replacement Sandra Batten
  23. 23. Supply side effects of climate change Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Supply component Labour supply Loss of hours worked due to natural disasters Loss of hours worked due to extreme heath Energy, food and other inputs Food and other input shortages Decrease in agricultural productivity Capital stock Damage due to extreme weather Diversion of resources from productive investment to adaptation capital Technology Diversion of resources from innovation to reconstruction and replacement Diversion of resources from innovation to adaptation capital Sandra Batten
  24. 24. Supply side effects of climate change Type of shock/impact Physical risks Transition risks From extreme weather events From gradual global warming Supply component Labour supply Loss of hours worked due to natural disasters Loss of hours worked due to extreme heath Reduced labour supply due to distortive taxation Energy, food and other inputs Food and other input shortages Decrease in agricultural productivity Risks to energy supply Capital stock Damage due to extreme weather Diversion of resources from productive investment to adaptation capital Diversion of resources from productive investment to mitigation activities Technology Diversion of resources from innovation to reconstruction and replacement Diversion of resources from innovation to adaptation capital Uncertainty about the rate of innovation and adoption of clean energy technologies Sandra Batten
  25. 25. Propagation of risks Sandra Batten
  26. 26. Propagation of physical risks Sandra Batten
  27. 27. Propagation of transition risks Sandra Batten
  28. 28. Conclusions Sandra Batten
  29. 29. Implications of climate change for fiscal sustainability • Direct effects of climate change on government budgets (mainly expenditure side) • Indirect effects of climate change on government budgets, through damage to the economy in both short and long run – Physical risks: damage to both expenditure and revenue side via reduction in aggregate output and wealth effects (Lis and Nickel 2010) • Propagation of risks between macro-economy and financial system: amplification, contagion and feedback risks. • Climate policy is a major source of transition risk for the macro-economy and the financial system: need to consider economic impacts of climate policy. Sandra Batten

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