C OPING WITH C OLLAPSE UNDER UNCERTAINTIES 01/12/2017 Gaël Giraud Florent Mc Isaac Emmanuel Bovari Central Banking and Green Finance #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 0/35 AGENCY
� Outlines 1 Introduction 2 Related Literature 3 Modeling set-up 4 Target achievements 5 Modeling uncertainty 6 Climate prospective 7 Concluding remarks 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 1/35
� Introduction – Research program The modelling tree Inequality Climate feedback loop Financial Markets Inventories Goodwin (1967) Keen (1995) Open economy Prices Multisectoral Government Banks Resources 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 2/35
� Introduction – Research program 1 . Climate feedback loops: climate-finance interplay–Stern-Stiglitz commission (2017). 2 . Inequality: Giraud-Grasselli (2017). 3 . Banks: Giraud-Kockerols (2015), European parliament report. 4 . Natural resources: Rostom-Giraud-Vidal (2017). 5 . Capital Vintage: Lojkine-Giraud (2017). 6 . Thermodynamics: Goupil-Herbert-d’Angelo-Giraud (2017). 7 . Brazil: On financing the energy shift. 8 . Other prospects: Colombia, Ivory Coast, Vietnam, Tunisia... 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 3/35
� Introduction Climate change is a milestone for the 21 st century 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 4/35
� Introduction The trouble with macroeconomics � Banchard (PIIE, 2016): I see the current DSGE models as seriously flawed... � Romer (2016): For more than three decades, macroeconomics has gone backwards... � Kocherlakota (2016): ...we simply do not have a settled successful theory of the macroeconomy. The choices made 25-40 years ago - made then for a number of excellent reasons - should not be treated as written in stone or even in pen. 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 5/35
� Introduction The role of private debt Nonfinancial Business; Credit Market Instruments; Liability, Level/Gross Domestic Product (left) Civilian Unemployment Rate (right) 11.2 5 10.4 4 9.6 3 8.8 2 % Chg. of (Bil. of $/Bil. of $) 8.0 1 Percent 7.2 0 6.4 -1 5.6 -2 4.8 -3 4.0 -4 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Figure: Change in private debt and employment rate in the United States – Period 1990-2010 fred.stlouisfed.org myf.red/g/7Dv0 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 6/35
� Introduction Research questions � Combine two sources of global instabilities, climate and finance, in a minimal dy- namic framework to perform a prospective analysis. Can climate change drive the global economy in a deep recessionary state? � Provide guidance for the implementation of public policy objectives in order to en- sure economic stability and perform the energy shift. Is a price signal sufficient? � Cope with climate as well as economic uncertainties in order to have a deeper understanding of our chances to meet to Paris Agreement’s objectives. What are our chances to stay below +2 ◦ C? 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 7/35
� Introduction Main findings � In a business as usual scenario, climate change drives the global economy toward a situation of “economic collapse.”- � A price signal (carbon tax) provides indeed the right incentives to perform the en- ergy shift and avoid most of climate damages. � However, financial risks are not entirely precluded: in line with the Stern-Stiglitz report (2017), a green public intervention is required to tackle both instabilities. � Our chances to achieve the Paris Agreement target stay, at most, below 25 % . 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 8/35
� Outlines 1 Introduction 2 Related Literature 3 Modeling set-up 4 Target achievements 5 Modeling uncertainty 6 Climate prospective 7 Concluding remarks 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 9/35
� Related Literature The Integrated Assessment Modeling (IAM) approach A workhorse model: the Dynamic Integrated Climate Economy (DICE) model of Nord- haus in a seminal series of papers (1993, 2013, 2014, 2016) � The Ramsey-Kass-Coopmans’ approach as a core macroeconomic model � A climate feedback loop with a damage function � A carbon price instrument to shape the energy shift Various extensions of the climate-economic interactions � Endogenous technological progress (Moyer, 2014) � Allocation of climate damages (Dietz and Stern, 2015) � Finance and green policies (Dafermos, 2016) This paper: assesses financial instability (Keen, 1995 and Grasselli et al ., 2012) 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 10/35
� Related Literature The approaches of Goodwin (1967) and Keen (1995) � Endogenous business cycles as in Goodwin (1967) � Dynamic interaction of deep macroeconomic behaviors ◮ Lotka-Volterra relationship linking the employment rate to the wage share ◮ Short-term Phillips curve (Mankiw, 2010 or Krugman, 2014) ◮ Investment as a function of profit share ◮ Dynamics of corporates’ private debt � Multiplicity of long-term equilibria ◮ A Solovian steady-state ◮ A bad attractor leading to a breakdown in the long-run ◮ Asymptotic local stability becomes key 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 11/35
� Related Literature Another view on public policy λ : employment rate ; ω : wage bill/GDP ; d: debt/GDP Source: Grasselli and Costa-Lima (2012) 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 12/35
� Outlines 1 Introduction 2 Related Literature 3 Modeling set-up 4 Target achievements 5 Modeling uncertainty 6 Climate prospective 7 Concluding remarks 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 13/35
� Modeling set-up Key modeling highlights Bridging climate and a global monetary economy 1 . The macroeconomic core ◮ Non-neutrality of money ◮ Severe breakdowns do not appear as “black swan events” ◮ Emissions, carbon price and abatement technology (Nordhaus, 2016) ◮ Price dynamics under imperfect competition (Grasselli et al ., 2014) ◮ Sigmoïd pattern of the global workforce (UN population scenarios, 2015) ◮ Dividends payments 2 . The DICE climate feedback loop of Nordhaus (2016) refined with ◮ More convex damage functions (Weitzman, 2011) ◮ Allocation of environmental damages between output and capital (Dietz et al ., 2015) 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 14/35
� Modeling set-up Stock-flow consistency Households Productive Sector Banks Sum Balance Sheet Capital stock pK pK Mh Mc Deposits − M Loans − Lc Lc − Ef − Eb Equities E Xh Xf = 0 Xb = 0 Sum (net worth) X current capital Transactions Consumption − pC pC Investment pI − pI Acc. memo [GDP] [ pY ] Wages W − W − ( δ + D K ) pK ( δ + D K ) pK Capital depr. Carbon taxes pTf − pTf Int. on loans − rc Lc rc Lc Bank’s dividends Π b − Π b Productive sector’s dividends Π d − Π d rM Mh rM Mc Int. on deposits − rM M Sh Sc − pI + ( δ + D K ) pK Sb Column sum (balance) Flow of Funds Change in capital stock p ˙ p ˙ K K Mh ˙ Mc ˙ − ˙ Change in deposits M Change in loans − ˙ ˙ Lc Lc Sh Sc Sb Column sum (savings) Ef − ( Sc + ˙ Change in equities ˙ pK ) Eb − Sb Change in bank equity ˙ Sh + ˙ pK + p ˙ Change in net worth 0 0 ˙ E K Table: Balance sheet, transactions, and flow of funds in the economy. 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 15/35
� Modeling set-up – The macroeconomic core Dynamics and behavioural relations � Short term Phillips curve: w ˙ w = φ ( λ ) � Dynamic of prices (Grasselli et al ., 2014): p ˙ p = η ( m ω − 1 ) � Investment behavior: I = κ ( π ) � Dynamics of private debt: ˙ D = I − Π − Π d � Taylor rule: r = max { 0 , r ∗ + i + φ ( i − i ∗ ) } � Dynamics of capital: K = I − ( δ + D K ) K ˙ 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 16/35
� Modeling set-up – The macroeconomic core Introducing climate change and public policies � Joint production process incorporating climate damages Y 0 min { K /ν ; aL } = ( 1 − D Y ) Y 0 1 − A ( p BS ) � � Y = Y 0 1 − n ( A ) � � E ind = σ � Public policies and aggregate profit pY − wL − rD − pT ( p C , E ind ) − ( δ + D K ) pK , Π = � Endogenous choice of the emission reduction rate in the productive sector �� p c 1 � � θ − 1 n = min ; 1 p BS 01/12/2017 #WorldInCommon AGENCE FRANÇAISE DE DÉVELOPPEMENT | FRENCH DEVELOPMENT AGENCY 17/35
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