Working papers
Working papers
Sovereign debt sustainability, the carbon budget and climate damages (2024), Swiss Finance Institute Research Paper No. 24-15
Sovereign debt sustainability, the carbon budget and climate damages (2024), Swiss Finance Institute Research Paper No. 24-15
This paper investigates the trade-offs between managing the financial sustainability of public debt and addressing climate change. Mitigation efforts and increasing temperatures imply economic costs that reduce countries’ growth rates, respectively in the short and in the long term. This can make the repayment of outstanding debt more difficult. I explore and quantify the evolution of debt limits –maximum sustainable debt-to-GDP– for advanced economies, under various scenarios, which respect, or not, the carbon budget constraints of the Paris Agreement. Various scenarios are analysed according to the costs of emissions’ abatement and the political coordination among countries in the transition. The evidence shows that failing to enforce a slowdown in emissions at a global level, and to stabilize climate damages, generate plunging debt limits in the medium-long term and shrinking fiscal spaces for all countries, even for the few ones actuating the transition. On the contrary, if the green transition is coordinated globally, debt limits converge to stable and higher levels, despite an initial and temporary decrease, given by the negative impact of emission reductions on GDP growth rates. From the evidence presented, it results as significantly more beneficial for countries to collaboratively and promptly transition towards mitigating climate impacts on growth and fiscal spaces. This will support sustainable public debt and the potential to finance the green evolution of our economies.
As the world faces rising temperatures, extreme weather events and environmental disruption, the imperative to mitigate climate change has never been more pressing. Yet the pursuit of effective mitigation could threaten the sustainability of public debt due to the potentially huge fiscal costs of the associated policies. This paper uses a dynamic general equilibrium approach that takes into account the macroeconomic implications of the green transition and its consequences for public finances. It shows that when the government relies too heavily on expenditure-based measures, it threatens the sustainability of public debt, by increasing the probability of sovereign default, leading to higher interest rates on government bonds. This higher public default risk has potentially significant repercussions on investment financing conditions for the private sector, and increases the cost of the transition to a net-zero economy. On the other hand, carbon pricing policies make the transition more viable for public finances, at the expenses of similarly high economic costs, while remaining effective in reducing greenhouse gas emissions.
This literature review, comprehensively explores the intricate relationships between climate change and sovereign debt sustainability. It is motivated by concerns regarding the long-term sustainability of unprecedentedly high debt-to-GDP levels and the worsening of climate events. After reviewing the scarce existing literature jointly addressing these two challenges, the paper outlines the traditional theoretical framework of public debt sustainability, discussing the debates around the sustainability of high levels of debt, the R<G condition, and the modeling of fiscal limits. Subsequently, the review engages with the economic impact of climate change, and the costs associated with the transition to a low-carbon economy. It critically analyzes the relationship between energy, emissions and GDP growth, presenting various modeling approaches that incorporate energy or emissions as a key input or by-product of output production functions. It explores, then, the climate and mitigation impacts on the other determinants of public debt sustainability besides economic growth: public finances (and the problematic political acceptability of carbon taxes) and base interest rates. By synthesizing a wide range of academic and policy perspectives, the review underscores the urgent need for integrated fiscal and environmental strategies and modeling frameworks, to address the dual challenges of climate change and sovereign debt sustainability.
Work in progress
Work in progress
Are Inflation Expectations Rational? A Joint Test on Market and Survey Data, jointly with Sofonias A. Korsaye and Yuelin Wang
The Green Transition, Public Finances and Monetary Policy in an E-DSGE model, jointly with Stéphane Dees
The fiscal limits of long-term debt