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The Carbon Bubble: climate policy in a fire‐sale model of deleveraging

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  • David Comerford
  • Alessandro Spiganti

Abstract

Credible implementation of climate change policy, consistent with the 2 °C limit, requires a large proportion of current fossil‐fuel reserves to remain unused. This issue, named the Carbon Bubble, is usually presented as a required asset write‐off, with implications for investors. We embed the Carbon Bubble in a macroeconomic model exhibiting a financial accelerator: if investors are leveraged, then the Carbon Bubble might precipitate a fire‐sale of assets across the economy, and generate a large and persistent fall in output and investment, impairing the economy's ability to invest in the zero carbon assets it needs to produce output in the post‐climate‐transition world. We find a role for macroeconomic policy protecting investors' balance sheets in mitigating the macroeconomic effects of the Carbon Bubble, and enhancing welfare.

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  • David Comerford & Alessandro Spiganti, 2023. "The Carbon Bubble: climate policy in a fire‐sale model of deleveraging," Scandinavian Journal of Economics, Wiley Blackwell, vol. 125(3), pages 655-687, July.
    • Handle: RePEc:bla:scandj:v:125:y:2023:i:3:p:655-687
    DOI: 10.1111/sjoe.12519
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    1. Huang, Bihong & Punzi, Maria Teresa & Wu, Yu, 2022. "Environmental regulation and financial stability: Evidence from Chinese manufacturing firms," Journal of Banking & Finance, Elsevier, vol. 136(C).
    2. Barbara Annicchiarico & Stefano Carattini & Carolyn Fischer & Garth Heutel, 2022. "Business Cycles and Environmental Policy: A Primer," Environmental and Energy Policy and the Economy, University of Chicago Press, vol. 3(1), pages 221-253.
    3. Huang, Bihong & Punzi, Maria Teresa & Wu, Yu, 2019. "Do Banks Price Environmental Risk? Evidence from a Quasi Natural Experiment in the People’s Republic of China," ADBI Working Papers 974, Asian Development Bank Institute.
    4. Francesca Diluiso & Barbara Annicchiarico & Matthias Kalkuhl & Jan C. Minx, 2020. "Climate Actions and Stranded Assets: The Role of Financial Regulation and Monetary Policy," CEIS Research Paper 501, Tor Vergata University, CEIS, revised 22 Jul 2020.
    5. Diluiso, Francesca & Annicchiarico, Barbara & Kalkuhl, Matthias & Minx, Jan C., 2021. "Climate actions and macro-financial stability: The role of central banks," Journal of Environmental Economics and Management, Elsevier, vol. 110(C).
    6. Huang, Bihong & Punzi, Maria Teresa & Wu, Yu, 2021. "Do banks price environmental transition risks? Evidence from a quasi-natural experiment in China," Journal of Corporate Finance, Elsevier, vol. 69(C).
    7. Etienne Espagne, 2018. "Money, Finance and Climate: The Elusive Quest for a Truly Integrated Assessment Model," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 60(1), pages 131-143, March.

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