Bridging the Gaps in Climate Policy

What are the aims and objectives of the CBES?

The first goal of the CBES exercise is to try and size the climate risks as the details around this are currently opaque. The other aim is to then highlight where opportunities are available to reduce the risk and identify where firms and customers business models need to change. The third aim of the exercise is to build  firms’ risk management capabilities and support them in developing a strategic long-term approach to managing climate risks.

Another important aspect of this is that firms as well as the Bank of England will be able to use this exercise to understand more about the climate risks and how they may crystallise as this will be a “learn by doing” type approach. 

What are policy levers?

The NGFS scenarios implemented by the Bank of England uses a shadow carbon price - one that acts as a  proxy for different potential policies. With regard to climate policies, the policies will need to create the relative price shift that internalises cost of emissions and pushes the economy towards net zero. The shadow analysis found that in order to successfully achieve net zero by 2050, the cost of emissions will be needed to increase up to $150 a tonne within a decade. We are still far away from capturing the true cost of emissions and the global price of carbon ($3 a tonne) reflects that. 

Policymakers and researchers need to work together in order to get more clarity around this to anticipate the challenges, opportunities that come with different climate policies. This will help them understand the right mix of policy tools that will help achieve net zero in swift, yet  smooth manner. They also need to work together to develop frameworks that capture the impact of different tools on the economy. 

What is the impact of macroeconomic models?

The June update of the NGFS scenarios included macroeconomic models with detailed outputs. A NiGEM model, tailor-made for the NGFS scenarios  was used to capture and show the effect on the economy. This helped identify the 4 key areas which need more work and research:

• A more complete integration of climate and macroeconomic modelling as the 2 individually dont model each other in much detail
• Understanding the different transmission channels and sizing them
• Obtaining a more in-depth look at distributed implications rather than just aggregate impacts as a whole. This includes different sectors, geographies and the NGFS is looking into scope of a sectoral model.
• Understanding how the transition will impact supply and demand sides 

What are the implications of monetary policy?

So far more emphasis has been on how central banks should implement monetary policies to support net zero rather than analysing the consequences of climate change for the monetary policy stance.

Domestic and international policy will have an impact o0n inflation, growth and labour markets, these impacts get bigger as more ambitious plans are put forth. As a result, we need to understand that physical risks from climate change will begin to factor into macro-variables and thereby increase the volatility of inflation rates. 

The structural shifts needed in the economy to achieve net zero will impact monetary policy as well as shifts can affect not only future point-in-time macroeconomic variables but also the expected long-run steady-state of variables. It is clear that more work on climate change and monetary policy needs to be done around:

• Transmission mechanism
• Macroeconomic variables for the conduct of monetary policy across different time horizon
• The natural interest rate