Climate change and macroeconomic policy space in developing and emerging economies

Abstract

This paper addresses the macroeconomic challenges stemming from the double affectedness of climate change and dependence on external finance in peripheral countries. The paper uses the Post-Keynesian concept of an asset’s own rate of return to assess how susceptibility to the combined effects of erratic capital flows and the vulnerability vis-à-vis the physical and transitional risks of climate change reduces macroeconomic policy space. Climate change and mitigation strategies are said to contribute to financial instability ensuing flight-to-quality of international investors. This translates into higher external financial fragility in low income countries with a high degree of commodity dependence—with increased exchange rate volatility and devaluating pressure deteriorating affected countries’ currencies’ liquidity premia and the expectation of their short-term exchange rates as result. Consequently, policy-makers in affected countries are forced to commit to investor-friendly policies and high interest rates to uphold their currencies’ acceptance. The susceptibility to the physical risks of climate change and mitigation hence contributes to the self-perpetuating nature of international monetary asymmetries and hierarchies.