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HomeToo late, too sudden
Transition to a low-carbon economy and systemic risk
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Keeping global warming below 2°C will require substantial reductions in global greenhouse gas emissions over the next few decades. To reduce emissions, economies must reduce their carbon intensity; given current technology, this implies a decisive shift away from fossil-fuel energy and related physical capital. In a benign scenario, the transition to a low-carbon economy occurs gradually: adjustment costs are manageable, and the repricing of carbon assets probably does not entail systemic risk. Nevertheless, in the absence of additional policy intervention or technological breakthroughs, it is likely that the stock of greenhouse gases in the atmosphere would continue to grow over the medium term. In an adverse scenario, the transition to a low-carbon economy occurs late and abruptly. Belated awareness about the importance of controlling emissions could result in an abrupt implementation of quantity constraints on the use of carbon-intensive energy sources. The costs of the transition will be correspondingly higher. This adverse scenario could affect systemic risk via three main channels: (i) the macroeconomic impact of sudden changes in energy use; (ii) the revaluation of carbon-intensive assets; and (iii) a rise in the incidence of natural catastrophes. First, a sudden transition away from fossil-fuel energy could harm GDP, as alternative sources of energy would be restricted in supply and more expensive at the margin. Second, there could be a sudden repricing of carbon-intensive assets, which are financed in large part by debt. Third, there could be a concomitant rise in the incidence of natural catastrophes related to climate change, raising general insurers’ and reinsurers’ liabilities. To quantify the importance of these channels, policymakers could aim for enhanced disclosure of the carbon intensity of non-financial firms. The related exposures of financial firms could then be stress-tested under the adverse scenario of a late and sudden transition. In the short-term, joint research efforts of energy experts and macroeconomists could help to better quantify macroeconomic risks and inform the design of scenarios for stress testing. In the medium-term, the availability of granular data and dedicated low-frequency stress tests will provide information about the impact of the adverse scenario on the financial system.
- Published:
- Corporate author(s): European Systemic Risk Board
- Subject: economic consequence , energy consumption , environmental protection , global warming , greenhouse effect , greenhouse gas , reduction of gas emissions
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| ISSN 2467-0685 | ISBN 978-92-95081-24-6 | DOI 10.2849/703620 | Catalogue number DT-AE-16-001-EN-N |
- Released on EU publications website: