2019/42 | LEM Working Paper Series | ||||||||||||||||
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The public costs of climate-induced financial instability |
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Francesco Lamperti, Valentina Bosetti, Andrea Roventini and Massimo Tavoni |
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Keywords | |||||||||||||||||
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Climate Change; Climate Impacts; Financial Crises; Public Debt; Macroprudential Policy.
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JEL Classifications | |||||||||||||||||
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C63, Q40, Q50, Q54
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Abstract | |||||||||||||||||
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Recent evidence suggests that climate change will significantly affect macro-economic
growth and several productive elements of modern economies, such as workers and land
[Dell et al., 2009, Burke et al., 2015, Carleton and Hsiang, 2016]. Although historical
records indicate that economic shocks lead to financial instability, few studies have
focused on the impacts of climate change on the financial system [Dietz et al., 2016,
Dafermos et al., 2018]. This paper evaluates a global economy where multiple banks
provide credit to production activities exposed to climate damages. We use an agent based
climate-macroeconomic model calibrated on stylized facts, future scenarios and climate
impact functions [Nordhaus, 2017] affecting labour and capital. Results indicate that
climate change will increase the frequency of banking crises (+26-148%). The public costs of
rescuing insolvent banks will cause an additional burden of about 5-to-15% of GDP per
year, and an increase of public debt to GDP by a factor of 2. We estimate that around
20% of such effects are caused by the deterioration of banks’ balance-sheets. Macroprudential
regulation attenuates bailout costs, but only moderately. Our results show that
leaving out the financial system from climate-economy integrated assessment may lead
to an underestimation of climate impacts, and that financial regulation can play a role in
mitigating them.
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