Economists shed light on the comparatively under-researched question of how climate change might affect the financial system and in particular, fiscal sustainability and sovereign debt markets.
Both the physical and transition-related impacts of climate change pose substantial
macroeconomic risks. Yet, markets still lack credible estimates of how climate change
will affect debt sustainability, sovereign creditworthiness, and the public finances of
major economies. We present a taxonomy for tracing the physical and transition impacts
of climate change through to impacts on sovereign risk.
We then apply the taxonomy to the UK’s potential transition to net zero. Meeting internationally agreed climate targets will require an unprecedented structural
transformation of the global economy over the next two or three decades. The changing
landscape of risks warrants new risk management and hedging strategies to contain
climate risk and minimise the impact of asset stranding and asset devaluation. Yet,
conditional on action being taken early, the opportunities from managing a net zero
transition would substantially outweigh the costs.
