Climate Economics and the Green Transition

Climate Economics: Macroeconomics of the Green Transition
Climate change is not only an environmental issue; it is also a first-order macroeconomic problem. Climate change affects GDP growth, inflation, financial stability, and fiscal sustainability. Transition to a low-carbon economy requires a massive redistribution of capital and labor. For investors and policymakers, climate economics is becoming a central framework.

Economics of Climate Change
Physical risks: Direct economic losses from climate events—hurricanes, floods, droughts, wildfires. Destruction of infrastructure, agricultural losses, health impacts. Estimates: 10-23% of global GDP by 2100 under business-as-usual (Stern Review, Network for Greening the Financial System).
Transition risks: Economic disruptions from the transition to a low-carbon economy. Stranded assets (fossil fuel reserves, carbon-intensive infrastructure), job losses in declining industries, investment requirements for new infrastructure.
Liability risks: Legal claims against companies for climate damages. Growing litigation trend.

Carbon Pricing
Carbon pricing is a central policy instrument for internalizing climate externalities.
Cap-and-trade: Government sets a cap on emissions, companies trade permits. EU ETS is the largest system. Price €80-100/ton CO2 (2024).
Carbon tax: Direct tax on emissions. Simpler administratively, but politically challenging.
Social Cost of Carbon (SCC): Estimated economic damage from an additional ton of CO2. EPA estimate: $50-200/ton. Used for cost-benefit analysis of policies.
Carbon Border Adjustment Mechanism (CBAM): EU tariffs on imports from countries without carbon pricing. Prevents carbon leakage, levels the playing field.

Macroeconomics of the Transition
Investment requirements: Achieving net zero requires $4-6 trillion annual investment in clean energy, infrastructure, efficiency. Massive reallocation of capital from fossil fuels to renewables.
Structural change: Declining industries (coal, oil & gas) vs. growing (solar, wind, batteries, EVs). Regional impacts are uneven—fossil-fuel dependent regions face adjustment challenges.
Inflation implications: Transition may be inflationary in the short term ("greenflation"). Carbon pricing raises energy costs. Supply constraints on critical minerals (lithium, cobalt). But renewables are cheaper in the long run.
Labour market: Just transition concept—supporting workers in declining sectors. Retraining, social safety nets, regional development policies.

Climate and Monetary Policy
Central banks increasingly incorporate climate: Climate stress tests for banks (ECB, BoE). Green bonds in asset purchases (some central banks). Climate-related disclosure requirements.
Debates: Should central banks actively promote the green transition, or is this a fiscal/regulatory domain?
Climate shocks and monetary policy: Supply-side climate shocks (droughts, disasters) create stagflationary pressure. Monetary policy trade-offs become more complex. Physical risks affect financial stability.

Fiscal Implications
Climate fiscal burden: Mitigation investments, adaptation costs, disaster relief, stranded asset losses. Estimates: 2-8% of GDP additional fiscal needs for net zero transition.
Carbon revenues: Carbon pricing generates significant revenues. EU ETS: €40B+ annually. Question: How to use them—reduce other taxes, climate investments, transfers?
Green public investment: Infrastructure (grids, charging, transport), R&D (hydrogen, carbon capture), industrial policy (subsidies, guarantees). US Inflation Reduction Act: $370B climate spending—the largest US climate legislation.

Investment Implications
Sector reallocation: Underweight fossil fuels, overweight clean energy, electrification, efficiency. ESG integration in portfolio construction.
Transition leaders: Companies actively decarbonizing may outperform laggards. Pricing of transition risks.
Stranded asset risk: Fossil fuel reserves may never be extracted. Coal especially at risk. Oil & gas has a longer runway, but terminal decline is visible.
Physical risk pricing: Real estate, agriculture, insurance sectors are most exposed. Geographic differentiation—coastal, flood-prone, heat-vulnerable regions at risk.
Green premium: Green bonds, sustainable real estate command a premium. Reflects demand, potential for regulation favor.