The Employment Dividend From Exports

Context: Ignoring climate risks will complicate macroeconomic management, just as overlooking financial risks eventually led to the global financial crisis.

Rising climate risks

• According to the International Energy Agency, 2023 is projected to be the year with the “greatest levels of carbon dioxide output in human history”.
• The Intergovernmental Panel on Climate Change’s Sixth Assessment Report has spelt out in detail that irreversible changes in climate due to human influence are witnessed across the globe.
• Economic activity, of practically any and every kind, is strongly cointegrated with emissions that contribute to climate change.

Contemporary Climate Risk Management by the Central Banks

• Under the transactions based framework: Central banks have regulations which make intermediaries recognise the possibility of climate risk drivers that alter (reduce) borrowers’ ability to repay and service debt.
  • This includes the likelihood that, in somewhat extreme circumstances, the recovery of a loan could be impaired — an event of default.
  • This recognition translates into apposite (usually higher) pricing of risk for the borrower and setting aside additional bank capital by the intermediary.  

Issues with the current climate risk management by the Central Banks:
 While the banks include risk management in transactions (loan recovery), monetary policies ignore the risks.

• The build-up of climate change-induced considerations seems to be ignored in monetary policy “reaction functions” of central banks.
• The banks thus limit their variable to just inflation and output gap to determine the state of an economy and bring out concomitant policies.

Checking the climate risks: There are five, not wholly independent, dimensions to take into account:

1. Effect of rising temperature and climate variability on short-term economic activity stemming from, say, disruptions due to extreme floods;
2. Regulatory restraint: National commitments made in Paris are akin to an additional constraint to maximising national output consistent with climate-neutral (or, “matters don’t worsen”) real economy outcomes;
3. Feedback loop from economic growth to higher GHGs;
4. Implications of rising temperatures, in the absence of requisite adaptation, on long-term economic capacity as emissions thresholds are breached, with resultant consequences for labour productivity, degradation of capital stock, and, indeed, even vitiate capability of the atmosphere to repair itself;
5. Expected changes in carbon- related tax and subsidy arrangements.

Conclusion:

• If sustainability is a defining characteristic of potential output, then it has to incorporate climate considerations. High inflation can no longer be the only symptom of macroeconomic infirmity if central banks are serious about the subject.
• Integrated assessment models have to be explicitly incorporated in central bank work that informs monetary policy. Therefore, monetary policy will have to adjust; otherwise “conduct as usual” by central banks can undermine climate goals.