Integrating climate change into macroeconomic analysis

Our changing environment has a powerful influence on the global economy. Henceforth, we can no longer discuss our economic future without considering the enormous aftermath of climate change. 

Extreme weather events and natural disasters are now considered the most likely and serious economic risks. If the notion of climate risks can first appear intuitive, measuring these risks is in fact still a quantitative puzzle.

Accordingly, climate integrated economy literally represents the incorporation of climatic constraints into the traditional economic framework. Commonly, the economic growth engine bases are an exogenous labor force or population, a productivity factor and the idea according to which capital is split between investment and consumption. Integrating climate into this framework suggests that the increasing temperatures will, one way or another, have an impact on growth.

Climate Change: The Ultimate Challenge for Economics

Unquestionably, climate change is a subject largely addressed from both macroeconomic and energetic outlooks. Integration of climate variables and natural capital into the traditional economic framework can appear conflicting with the notion of infinitely growing economies exploiting finite resources, which questions the sustainability of neoclassic economic growth models. Moreover, the temporal dimension is of paramount importance and the integration of inter-temporal utility is not a frivolous issue. The construction of complex general equilibrium models is a way to model the response of economic systems to shocks.

IAM and DICE models

The economic models we explored, primarily based on an integrated assessment model (IAM) combining scientific and socio-economic aspects of climate change for the purpose of assessing impacts and policies alongside William Nordhaus’ DICE model. The Nobel-prize winner, who is considered to be a leading authority on the economics of climate change, has elaborated this model called DICE, for Dynamic, Integrated Climate and Economics. In light of this and to fully understand the model and all of the logic, a bit of background is needed thereby to carry out some experiments enabling us to examine the consequences of different policy options regarding the reduction of carbon emissions. In this section, we also question model outputs with respect to the underlying uncertainties and their failure to represent the world’s complexity.

Understanding Investment Opportunities

Despite the flaws of these frameworks, they are the only tools available to make out-of-sample estimates. Consequently, our view is that extending these models to model endogenous growth rates and including the financial market and particularly investor’s range of different beliefs could be a question to address.

Will we efficiently reduce the negatives implied by our economic activity or face the consequences? Therefore, the two aspects an investor wishes to assess is to what extent his portfolio contributes to the reduction of social and environmental negatives, and how it contributes to the improvement of global resiliency.

Consequently, further disclosure and data support are required to allow asset managers to track portfolio-specific abatement costs relative to emissions induced and to implement, for instance, robust constrained portfolio alignment strategies. More generally, to better integrate both short- and long-term objectives, financial pricing models must encompass multiple modules to adopt optimal strategies in the changing landscape.

Inspiring other economists to focus on the crucial role of risk and uncertainty

For much of his career, William Nordhaus has been urging economists to understand the full importance of climate change and integrate it into their models. One thing for sure, the Nobel-prize winner has been making that case for more than quarter a century. It’s about time the rest of the world swinged into actions.

Follow the main highlights of his talk

 on June 13th via live tweets on

#AmundiWIF19

Follow the main highlights of his talk on June 13th via live tweets on

#AmundiWIF19