As we transition our economies to a low-carbon path, climate-related transition risks to the financial sector pose a challenge to policymakers in their policy design. Central banks can play an essential role in facilitating a successful transition by directing the funds needed to achieve this transition in a timely manner and thus reducing systemic risks. However, any intervention by central banks should be evaluated across sectors and across scenarios in order to guarantee effectiveness, efficiency, and coherence with fiscal policies.
Our methodology is scenario analysis based on a modified Computable General Equilibrium model, which allows us to capture feedback loops across sectors, along with tracking the change in prices and quantities following an exogenous change in policies, technologies, or consumer preferences. Moreover, in order to capture both risks and opportunities associated with the transition process, our model distinguishes between clean and dirty subsectors. It also uses sector-specific capital stocks, which allows us to differentiate the cost of capital across sectors and scenarios. The model output includes quantitative effects of exogenous policy change on cash flows, return on invested capital, asset values, price levels, inflation, and many other variables across modelled sectors and scenarios. Such information can be used to stress test investment portfolios and financial stability under different monetary, supervisory, and fiscal interventions. We believe that our approach is an innovative one that contributes to answering key questions about the impacts of central banks’ policies and operations on the costs of different pathways for the energy transition, through both the performance of the financial system and the possible changes in the real economy.