Macroeconomic and fiscal implications of climate change and the policies to address it

11 April 2008 | Minutes

11 April

Erich Vogt, IUCN, moderator

  • Climate Change is a cross-sector challenge
  • IMF used to say climate change "is not of concern to the IMF", not on their radar screen
  • But IMF staff have worked on this and worked with others outside the IMF

Michael Keen, FAD, former head of tax policy division, IMF
Natalia Tamirisa, IMF Research deputy division chief, IMF

Joint presentation by Michael and Natalia

Michael Keen, presentation

  • IMF EDs discussed climate change, IMF won’t be a lead organisation, but it sees a mandate to make a contribution based on issues of macroeconomic and fiscal significance
  • The economics of climate change
    • this is a collective action problem, externalities are key, corrective taxes are usually the best way to deal with this
    • Complications of dealing with climate change:
      • Costs of mitigation long before benefits – discount rate is critical; but need quick action because of long-term stocks of GHGs
      • Uncertainty is considerable
      • Possibility of catastrophic damages
      • Free-rider problem – requiring international cooperation
      • Differences in vulnerability and historical and perspective responsibility


  • Economics of climate change
    • Future damages uncertain, but could be large (3-35% loss of GDP loss)
    • Problem of non-market impacts – things that have no values in the market (like increase likelihood of disease, biodiversity, water etc)
    • Factor contributing to uncertainty: climate sensitivity; time preference, equity, nonmarket factors, etc
    • Distribution of damages is quite uneven – developing and emerging markets most at risk
    • Emissions growth driven by catching up economies – reflecting economic development


  • Adaptation
    • For slow moving aspects of climate change – adaptation should be left to private sector
    • Potential role for public sector: climate-proofing investments; responding to additional public spending needs will require trade-offs; dealing with fiscal risk through self- and market-insurance (especially cautious fiscal position)
    • Magnitude – WB est is tens of billons of dollars – how much to fall on the public sector? Country distribution of costs?
      • Financial instruments also to play a role – catastrophe bonds, weather derivatives
      • Macro and structural policies can help facilitate adjustments – need flexible exchange rates and financial liberalisation for quick recoveries from shocks
  • Mitigation
    • Carbon pricing and taxes – differing views of appropriate prices ($15-60, up to $100)
    • Modest but sustained increase over time (market expectations)
    • Other policies – performance standards, technology incentives, deal with related market failures
    • Methods: taxation; cap and trade; hybrids
      • Difference – do you fix quantities of emissions or price of carbon
      • Which is better? Depends if you know abatement costs or not? Also requires auctions of permits in cap and trade
      • If abatement costs uncertain, preference for taxation as getting emissions wrong over short interval is not too costly – damage comes from stock; if you get price wrong then it can be very costly


  • Mitigation models
    • Used G-cubed global dynamic macro-economic model – not technological, sectoral modelling
    • Category 3 levels from IPCC – to 550 ppm atmospheric level
    • Assume global uniform carbon tax and look at macroeconomic effects
    • Focus on consumption loss – three scenarios (world uniform tax, trade based on initial emissions and population-based allocation)
    • Financial transfers sensitive to allocation scheme – population share allocation better for developing countries
    • Also very sensitive to assumptions on the costs of reducing emissions – so country-specific results are not robust

Michael – Conclusions and role of the Fund

  • Long-term and credible prices, broad-based pricing is needed, common price, flexible, equitable
  • Supportive macro policies – capital flows, tech transfers, managing transfers (Dutch disease)
  • Role of the Fund- to advise where macro-relevant issues, contribution to wider debate


Noah of EDF – where do marginal abatement cost curves come from?

Natalia – abatement costs depend solely on energy intensity of the economy

Noah – timing of policy introduction?

Natalia – in the publications all at once; we did some models of mixed introduction but this means costs too high for rich countries

Noah – Greater uncertainty of damage means we should use quantity as the target

Michael – Damage occurs on which instrument you use; in practice it has to be changed all the time; we don’t know a critical threshold; we can’t worry too much about fat-tail damage

Joseph of Nigeria – involved in renewable energy projects

  • Effectiveness of emissions trading on mitigating change; transaction costs are quite high (50%) of the emissions reduction because of assessment, monitoring, etc.


  • yes many problems in trading schemes now, but carbon markets can operate more smoothly
  • Africa can be a significant seller – meaning it is an opportunity to LICs

Questioner – investment and output deviation in OPEC?

Natalia – reduced demand for oil is the link to lower investment and output

Italian foreign ministry – cap and trade scheme vs. taxation – implementation?

  • Carbon pricing and performance standards?

Michael – preference is a uniform carbon price; no detail on floors on schemes; but linking schemes will be a future research agenda

  • No comparison of pricing vs performance standards explicitly; no work on the welfare cost trade-offs of this
  • Performance standards are not the first best instrument
  • Though we know fiscal instruments are not the only instruments to be used, but a natural area of IMF work

Natalia – performance standards useful for dealing with market failures like diffusion

Bhumika – what about the role of the IMF in LICs? ESF? Other loan instruments to discuss for adaptation and disaster response?

  • Fiscal space by rationalising expenditure? What does that mean? Where to WB climate funds come in? Where is external borrowing?

Michael – additional instruments not being considered

  • Need to know more info on costs and countries – we need more specific info on demands on public sectors in these countries
  • We are reliant on other institutions to find volume of fiscal costs
  • Reform – PEM pension etc – the normal kinds of advice on fiscal reduction
  • We know fiscal space is hard to create – we don’t say this lightly

Miguel from Chile – very wary of solutions that require interventions because of corruption risks; is there literature on the risks

Michael – see upcoming paper on fiscal instruments towards energy policy in the G7

  • We recognise that there is a mess of ad-hoc measures out there in countries – so uniform carbon pricing for example is very hard to achieve
  • First step might have to be rationalisation/reform of fiscal aspects of energy policy

Tanim from Bangladesh – usage of funds from carbon taxation?

Michael – We don’t have a view on allocating revenue, but this is fundamental question, we can advise on implications

Peter Chowla – choice of stabilisation level?


  • We picked middle range from IPCC at 550 ppm, not the least ambitious but we are not experts
  • Focus was not on the stabilisation goal, just one of the assumptions to calibrate the mechanism

Michael – fiscal paper does 450, 550, 650 words

Paul of UDC and New Rules for Global Finance – relation of FDI to adaptation/mitigation; investment relation to unemployment?

Michael – we are agnostic on both of these.

Natalia – opportunities from mitigation not discussed, but yes green sector is interesting

Benjamin from Nigeria – collaboration with countries on impacts

Michael – the IMF will do advice and expertise on our traditional areas of expertise

Natalia – WB needs to address this question more, as they deal with development issues