The Effects of the Financial System and Financial Crises on Global Growth and the Environment

Abstract

The paper considers the links between financial system, economic growth and environmental pollution and damages through: (1) investment in the real economy; and (2) financial instruments for environmental policy. The literature on the effect of finance on pollution is dominated by econometric studies of the effect of financial variables on the Environmental Kuznets Curve. The paper reviews this literature and finds that financial development in general, apart from financial crises, tends to reduce pollution. The paper will explain how financial crises affect the environment through reductions in effective demand, by forcing a switch to earlier technologies, and by encouraging the use of lower-cost, more polluting fuels. The paper explores the causative links between the nature of the recession and the reduction in long-term GDP growth via reductions in the share of investment in GDP. This is followed by an exploration of the necessity of investment and green banking in encouraging environmentally friendly development pathways. It will discuss the problems in modelling the effects of the financial system on the real economy, especially in respect of long-term growth and environmental pollution, with a focus on climate change and the mitigation of climate change.