Twenty-year tango: Exploring the reciprocal influence of macro-financial instability and climate risks

Abstract

This study presents a novel investigation of the reciprocal relationship between financial instability and climate risks, focusing on the influence of climate policy uncertainty within the US financial system from a macroeconomic perspective. By adopting the bootstrap rolling-window causality method, the analysis captures structural changes over an extended period between January 2000 and March 2021. Importantly, this method provides a robust data-driven approach, avoiding ad hoc assumptions about temporal breakpoints. The results support the climate fragility hypothesis, highlighting the amplifying effect of financial instability on climate risks. The study reveals that periods of economic and political turbulence exacerbate these effects by generating substantial financial turbulence, which, in turn, influences climate policy. The results also indicate that climate policy uncertainty contributes to worsening financial instability during critical events such as sudden changes in interest rates and major financial crises. The implications of this research extend to policymakers and investors, encouraging them to integrate climate factors into decision-making processes and adopt sustainable practices to promote financial stability and mitigate climate-related risks.