The International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE), a stakeholder of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), has awarded a team of Georgia State University economists $50,000 to develop a first-of-its-kind model that will reveal the fuller impact of climate change and climate policy on regional and national financial systems and economies.
The new model will explore how financial frictions amplify the economic impacts of climate damage to an extent not yet measured in the Integrated Assessment Models (IAM) currently used.
The research team is led by principal investigator Stefano Carattini and includes co-investigators Mathilda Eriksson, a visiting senior research associate of the Department of Risk Management & Insurance in the J. Mack Robinson College of Business, Garth Heutel and Givi Melkadze. Carattini and Melkadze are assistant professors and Heutel is an associate professor in the Andrew Young School of Policy Studies.
“Financial stability is super policy-relevant to measures of climate impact,” Carattini said. “The Securities and Exchange Commission, Federal Deposit Insurance Corp. and the Office of the Central Comptroller all have proposals under comment related to financial stability and climate.”
When IAM models are used today, important dynamics are missing from the results. For example, to examine the consequences of climate policy interventions like carbon taxes, IAM models assume the financial sector is frictionless, or that all banks know what assets other banks hold. By adding financial friction to these calculations, economists are developing a model that will more accurately show the costs of climate damage.
“That’s why the central banks are so interested in what we’re doing,” Carattini said. “Our plan is to introduce financial frictions into the IAM framework so that if a country is hit by a big natural disaster, we can see how the financial markets will respond and be able to capture economic losses that may be larger than what current models predict.”
Policymakers and other stakeholders will be able to use the new model to better anticipate problems and look at different policies that would improve their response. For example, the model will tell which banks should be required to have larger reserves to ensure an adequate response to climate change.
“Until recently, people — including central banks and policymakers — were seeing the effects of climate change as far in the future,” Carattini said. “Now that we’re all seeing these effects happening more often and in larger ways, there’s much more interest in these models. Central banks and policymakers are more willing to use them in their decision-making.”
Carattini, who has presented to the central banks of England, Spain and France, admitted the timeline for this project is purposefully ambitious. “The idea is to have a working paper in a year, put it in the public space for presentations and comments, and then finalize it as a scientific publication. We’ll make sure all are aware of our findings.”
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