Abstract
ABSTRACTThis article outlines a critical gap in the assessment methodology used to estimate the macroeconomic costs and benefits of climate and energy policy, which could lead to misleading information being used for policy-making. We show that the Computable General Equilibrium (CGE) models that are typically used for assessing climate policy use assumptions about the financial system that sit at odds with the observed reality. These assumptions lead to ‘crowding out’ of capital and, because of the way the models are constructed, negative economic impacts (in terms of gross domestic product (GDP) and welfare) from climate policy in virtually all cases.In contrast, macro-econometric models, which follow non-equilibrium economic theory and adopt a more empirical approach, apply a treatment of the financial system that is more consistent with reality. Although these models also have major limitations, they show that green investment need not crowd out investment in other parts of the economy – and may therefore offer an economic stimulus. Our conclusion is that improvements in both modelling approaches should be sought with some urgency – both to provide a better assessment of potential climate and energy policy and to improve understanding of the dynamics of the global financial system more generally.POLICY RELEVANCEThis article discusses the treatment of the financial system in the macroeconomic models that are used in assessments of climate and energy policy. It shows major limitations in approach that could result in misleading information being provided to policy-makers.
Highlights
The focus of this article is on the impacts of assumptions in macroeconomic modelling approaches, and it is necessary to have a basic understanding of the underlying theory and philosophy in order to understand how the models work
All trained economists are familiar with the Efficient Markets Hypothesis (EMH) that forms the core of financial theory in neoclassical economics
If the world is to meet the 2°C target, it is clear that substantial levels of additional investment will be required. How this investment is financed is a key question for policy makers, as has become clear from the United Nations Framework Convention on Climate Change (UNFCCC) negotiations in recent years
Summary
The previous section showed that the treatments of money and finance vary considerably between the different strands of economic theory. We turn attention to the practical application of these theories through computer models. The explanations focus on the assessment of climate and energy policy but it would be possible to draw the same conclusions for any type of policy that was investment intensive and for which the model user was interested in the long-run outcomes. It is important to note that all the different models observe the macroeconomic identity that savings should equal investment but, as explained below, they have quite different interpretations of how the balance is met. We summarize the key differences between the two most commonly applied modelling approaches and provide an example relating to climate policy. We discuss some of the other conceptual approaches that could be applied in the future
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
