Climate Change, Financial Stability and Monetary Policy

Using a stock-flow-fund ecological macroeconomic model, we analyse (i) the effects of climate change on financial stability and (ii) the financial and global warming implications of a green QE programme. Emphasis is placed on the impact of climate change damages on the price of financial assets and the financial position of firms and banks. The model is estimated and calibrated using global data and simulations are conducted for the period 2015-2115. Four key results arise. First, by destroying the capital of firms and reducing their profitability, climate change is likely to gradually deteriorate the liquidity of firms, leading to a higher rate of default that could harm both the financial and the non-financial corporate sector. Second, climate change damages can lead to a portfolio reallocation that can cause a gradual decline in the price of corporate bonds. Third, financial instability might adversely affect credit expansion and the investment in green capital, with adverse feedback effects on climate change. Fourth, the implementation of a green QE programme can reduce climate-induced financial instability and restrict global warming. The effectiveness of this programme depends positively on the responsiveness of green investment to changes in bond yields