The Unassuming Economist

From a new working paper by Vivek Ghosal, Andreas Stephan, Jan F. Weiss:

“Using a unique plant-level dataset we examine total factor productivity (TFP) growth and its components, related to efficiency change and technical change. The data we use is from Sweden and for their pulp and paper industry, which is heavily regulated due to its historically large contribution to air and water pollution. Our paper contributes to the broader empirical literature on the Porter Hypothesis, which posits a positive relationship between environmental regulation and “green” TFP growth of firms. Our exercise is innovative as Sweden has a unique regulatory structure where the manufacturing plants have to comply with plant-specific regulatory standards stipulated at the national level, as well as decentralized local supervision and enforcement. Our key findings are: (1) prudential regulation limits expansion of plants with high initial pollution; (2) regulation, however, is not conducive to plants’ “green” technical change, which provides evidence against the recast version of the Porter Hypothesis; (3) decentralized command-and-control regulation is prone to regulatory bias, entailing politically motivated discriminatory treatment of plants with otherwise equal characteristics.”

From VoxEU:

With global emissions of CO₂ still growing, understanding the determinants behind energy use and emissions is as relevant as ever. This column looks at the role of per capita income and consumption choices. It finds that the share of expenditures spent on energy and energy-intensive goods tends to decrease with income across a large set of countries. Simulations indicate that income growth shifts consumption patterns in a way which generally reduces emissions. However, increasing emissions in low- and middle-income countries as well as a shift from direct to indirect consumption of energy mean that the effect on total world emissions is modest.

The consumption of energy is associated with numerous negative externalities. Fossil fuels, specifically, cause emissions of CO₂, the most prevalent greenhouse gas. With the issue of climate change far from resolved, understanding the determinants behind emission levels is necessary to improve forecasting and guide policy making.

There is ample empirical evidence that energy demand depends on per capita income. In high-income countries, a number of single-country survey-based studies find that rich households spend a smaller share of their income on energy (e.g. Dubin and McFadden 1984). Less is known about this relationship in the developing world, where most of the growth in energy demand is currently taking place. A number of studies find that energy demand also increases slower than total expenditures in middle-income countries, including in China (e.g. Cao et al. 2016). On the other hand, as large populations are just beginning to purchase energy-intensive appliances (fridges, air conditioners, cars), it is feared that energy demand in the developing world may keep growing rapidly (Auffhammer and Wolfram 2014, Gertler et al. 2016).

More generally, the structural change literature has clearly documented that consumers of different income levels prefer different sets of goods (e.g. Comin et al. 2018), generally shifting from agriculture to manufacturing to services as income grows. Yet we still do not have a clear picture of the aggregate consequences for energy consumption, and what the relationship between income, consumption patterns and CO2 emissions looks like in the aggregate. This relationship directly affects the CO₂ intensity of GDP, a critical ingredient when trying to project emissions and understand the potential magnitude of climate change. A quick survey of prominent emission projection models (from academics, governments, or international agencies) also shows that these models tend to incorporate income effects in consumption in a rather crude manner, as they are typically more focused on technology assumptions.

Our recent article (Caron and Fally 2018) systematically summarises the implications of shifting consumption patterns on energy demand and emissions. We take an aggregate view across countries spanning most of the per capita income spectrum and all sectors of the economy. Our framework, an extension of the general equilibrium model described in Caron et al. (2014), links non-homothetic household preferences (i.e. with non-trivial income effects) to emissions through production and trade linkages. The model allows us to uncover patters of comparative advan­tage in the production of CO₂-intensive goods. We can thus identify the role of income in determining energy demand, making sure that we are not confound­ing it for differences in the availability of energy or energy-intensive goods and services across countries.

The relationship between income elasticity and emissions intensity across sectors

Do high income consumers prefer goods which are, coincidentally, less CO₂ intensive in their production?

Using different types non-homothetic preferences, we estimate the income elasticity of goods in 50 sectors of the economy. As many before us, we find a clear role for per capita income in determining consumption patterns – the income elasticity of most sectors is significantly different from one.

The directconsumption of energy generally increases slower than income. Figure 1 shows that the two main energy goods consumed directly by households, electricity (ely) and refined oil (p_c, mostly gasoline for transportation), have an income elasticity below one. While these estimates reflect an average across all countries, they depend on income – energy consumption is more income-elastic in low-income countries. This is consistent with scattered country-level evidence from the literature.

However, just looking at direct energy consumption is misleading. It ignores the emissions embodied in the consumption of non-energy goods – think of the emissions caused by the production of the steel and leather constituting the chair you are sitting on, and so on. Tracking ‘indirect’ emissions throughout global supply chains (based on intermediate input and trade linkages), we can compute the ‘total’ emissions associated with the consumption of each good. Plotting income elasticity against total (embodied) CO₂ intensity, Figure 1 reveals an ‘inverted-U’ relationship – sectors of intermediate income elasticity have, on average, the highest CO₂ intensity. But it is also asymmetric and negative overall, with high-income-elasticity sectors having the lowest CO₂ requirements on average.

We insist that this represents an ‘incidental’ correlation – high-income consumers do not necessarily prefer these goods becausethey are less emissions intensive.”

 

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From a new paper by Enno Schröder and Servaas Storm:

“The unmistakably alarmist tone of the ‘Hothouse Earth’ article stands in contrast to more upbeat reports that there has been a delinking between economic growth and carbon emissions in recent times, at least in the world’s richest countries and possibly even more globally. The view that decoupling is not only possible, but already happening in real time, is a popular position in global and national policy discourses on COP21. To illustrate, in a widely read Science article titled ‘The irreversible momentum of clean energy’, erstwhile U.S. President Barack Obama (2017), argues that the U.S. economy could continue growing without increasing CO2 emissions thanks to the rollout of renewable energy technologies. Drawing on evidence from the report of his Council of Economic Advisers (2017), Obama claims that during the course of his presidency the American economy grew by more than 10% despite a 9.5% fall in CO2 emissions from the energy sector. “…this “decoupling” of energy sector emissions and economic growth,’ writes Obama with his usual eloquence, “should put to rest the argument that combating climate change requires accepting lower growth or a lower standard of living.

(…) And International Monetary Fund economists Cohen, Tovar Jalles, Loungani and Marto (2018), using trend/cycle decomposition techniques, find some evidence of decoupling for the period 1990-2014, particularly in European countries and especially when emissions measures are production-based. The essence of the decoupling thesis is captured well by the title of the OECD (2017) report ‘Investing in Climate, Investing in Growth’. The OECD report, prepared in the context of the German G20 Presidency, argues that the G20 countries can achieve ‘strong’ and ‘inclusive’ economic growth at the same time as reorienting their economies towards development pathways featuring substantially lower GHG emissions.”

 

From the IMF’s latest report on Belize:

“Belize is exceptionally vulnerable to natural disasters and climate change. It already faces hurricanes, flooding, sea level rise, coastal erosion, coral bleaching, and droughts, with impacts likely to intensify given expected increases in weather volatility and sea temperature. Hence, planning for resilience-building, and engagement with development partners on environmental reforms, have been central to Belizean policy-making for many years, since well before Belize submitted its Nationally Determined Contribution (NDC) to the Paris Accord in 2015.

This Climate Change Policy Assessment (CCPA) takes stock of Belize’s plans to manage its climate response, from the perspective of their macroeconomic and fiscal implications. The CCPA is a joint initiative by the IMF and World Bank to assist small states to understand and manage the expected economic impact of climate change, while safeguarding long-run fiscal and external sustainability. It explores the possible impact of climate change and natural disasters on the macroeconomy and the cost of Belize’s planned response. It suggests macroeconomically relevant reforms that could strengthen the likelihood of success of the national strategy and identifies policy gaps and resource needs.

• General preparedness for climate change. Belize’s planned climate response is well articulated. Its NDC includes a clear strategy with relatively well-developed costing for its mitigation and adaptation activities. But while climate planning is advanced and consistent with the broader development strategy (GSDS), implementation capacity remains a challenge. Belize has strong physical emergency planning but receives comparatively little disaster aid and falls short on longer-term financial provisioning.

 

• Mitigation. Belize plans to meet its NDC mitigation goals by expanding its already relatively high share of renewable energy further (from 57 percent to 85 percent of electricity supply), reducing energy intensity and fossil fuel use in transport, and protecting forest reserves and improving sustainable forest management. Given its already-reduced dependence on fossil fuels, and its need to preserve competitiveness with Caribbean neighbors, it has limited scope to raise carbon taxes unilaterally; however, feebates could improve the mitigation incentives in the tax system.

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From a speech by Benoît Cœuré, Member of the Executive Board of the European Central Bank:

“2018 has seen one of the hottest summers in Europe since weather records began.^[1]Increasing weather extremes, rising sea levels and Arctic melting are now clearly visible consequences of human-induced warming.^[2] Climate change is not a theory. It is a fact.

While only one dimension of the human cost, the consequences in macroeconomic terms look set to be large. Without further mitigation, cumulative emissions pose significant risks of economic disruption.^[3]

While there is a wide recognition that environmental externalities should be primarily corrected by first-best policies, such as taxes^[4], all authorities, including the ECB, need to reflect on, and consider, the appropriate response to climate change.

In recent years, central bankers, led by Bank of England Governor Mark Carney, have started discussing the financial stability implications of climate change.^[5] The first tangible results are trickling in. The Financial Stability Board’s Task Force on Climate-related Financial Disclosures published its first status report just a few weeks ago. Only last week, ECB Banking Supervision communicated to banks that climate-related risks have been identified as being among the key risk drivers affecting the euro area banking system.

And, of course, the Central Banks and Supervisors Network for Greening the Financial System published its first progress report just a few weeks ago, reasserting that climate-related risks fall squarely within the supervisory and financial stability mandates of central banks and supervisors.

An area that has received less attention though, both in policy and in academia, is the impact of climate change on the conduct of monetary policy. Today I would like to contribute to this debate and offer a way of thinking about how climate change fits into our current monetary policy framework – the way we react to shocks and the way we think policy propagates through the economy – and how it may affect our monetary policy implementation.

I will argue that climate change can be expected to affect monetary policy one way or the other. That is, if left unchecked, it may further complicate the correct identification of shocks relevant for the medium-term inflation outlook, it may increase the likelihood of extreme events and hence erode central banks’ conventional policy space more often, and it may raise the number of occasions on which central banks face a trade-off forcing them to prioritise stable prices over output.

In the more desirable scenario in which humankind rises to the climate change challenge, the implications for monetary policy could be equally far-reaching, in particular if the associated shift in the energy mix changes relative prices to an extent that risks destabilising medium-term inflation expectations.

I will also argue that there is scope for central banks themselves to play a supporting role in mitigating the risks associated with climate change while staying within our mandate.”

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