Building a macro-financial integrated-assessment model for ordered transitions and fiscal-monetary policy interactions

Assessing the impacts of climate change-related physical and transition risks on the financial system and the macroeconomy is one of the most urgent and prominent needs to support climate policy design. However, the modelling toolbox for the assessment of these risks is currently rather scant.

We contribute to filling this gap by developing a macro-financial model that brings a detailed energy sector into a macroeconomic agent-based model with heterogenous banks and cross-sectoral exposures. The advantage of the proposed framework is twofold: It builds on two consolidated models in their respective domains (macro-financial and integrated assessment modelling) and includes a representation of both micro-level indicators of economic activity (e.g., insolvency rates, mark-ups, productivity dispersion, non-performing loans) and macro-level indicators (e.g., output growth, volatility, unemployment, public debt). Crucially, the macroeconomic properties will emerge indirectly from the decentralised interactions of individual agents and will possibly show non-linear and threshold effects (e.g., due to contagion).

After calibrating the model, we structure the project around two main applications. First, the model will be used to assess how the transition pathways of major emission/socio-economic scenarios and the associated changes in the climate would affect macroeconomic fundamentals and financial stability. Our results will add a macro-financial perspective to the scenario narratives. Second, building on previous work of the project team, we are testing a variety of climate-related fiscal, monetary, and macroprudential policies, with the aim of studying whether a target to physical or transition risks from climate change could hide trade-offs or double-dividends.