Climate Change, Financial Stability and Monetary Policy

TLDR

The study uses a stock‑flow‑fund ecological macroeconomic model to examine how climate‑change damages affect financial asset prices, firms’ and banks’ financial positions, and the implications of a green QE programme. The model is calibrated with global data and simulated for 2016–2120. The simulations show that climate change damages erode firm liquidity, depress corporate bond prices, and constrain credit expansion, but a green QE programme can mitigate these effects and limit warming, with its success depending on green investment sensitivity to bond yields.

Abstract

Using a stock-flow-fund ecological macroeconomic model, we analyse (i) the effects of climate change on financial stability and (ii) the financial and global warming implications of a green quantitative easing (QE) programme. Emphasis is placed on the impact of climate change damages on the price of financial assets and the financial position of firms and banks. The model is estimated and calibrated using global data and simulations are conducted for the period 2016–2120. Four key results arise. First, by destroying the capital of firms and reducing their profitability, climate change is likely to gradually deteriorate the liquidity of firms, leading to a higher rate of default that could harm both the financial and the non-financial corporate sector. Second, climate change damages can lead to a portfolio reallocation that can cause a gradual decline in the price of corporate bonds. Third, climate-induced financial instability might adversely affect credit expansion, exacerbating the negative impact of climate change on economic activity. Fourth, the implementation of a green corporate QE programme can reduce climate-induced financial instability and restrict global warming. The effectiveness of this programme depends positively on the responsiveness of green investment to changes in bond yields.