Expectations matter
By Simone Maxand & Joschka Wanner

3rd Berlin Climate Macro Workshop

Which role can central banks play in climate policy? What are the implications of climate change and climate policy for economic growth? How can government policy foster technological change that can lead the way towards the green transformation? These are some of the questions asked in the field of climate macroeconomics. On November 4, 2022, around 20 Berlin School of Economics researchers gathered at the University of Potsdam for the third Berlin Climate Macro Workshop to explore and discuss some of these questions. Four presentations and one keynote by Sjak Smulders from Tilburg University shed light on a wide range of topics in climate macroeconomics.

First off, Anna-Maria Göth from the Humboldt University of Berlin presented joint work with Michael Burda and Leopold Zessner-Spitzenberg on “Green Transition and Investment – The Optimal Path of Capital Accumulation”.

The second presentation stayed with the investment theme. Specifically, Ulrich Eydam from the University of Potsdam talked about his joint project with Francesca Diluiso on “Public Infrastructure and Green Investments”.

In his keynote speech, Sjak Smulders presented “Self-fulfilling Prophecies in the transition to Clean Technology”, which is a joint paper with Sophie Lian Zhou. The key point of his presentation was the role of expectations and how the same climate policy can lead to very different outcomes depending on the expectations of market participants, making a broader set of climate policies necessary that can succeed in steering expectations and hence the economy towards a green transition.

The fourth speaker was Achim Hagen from the Humboldt University of Berlin, who presented a paper with Angelika von Dulong and Niko Jaakkola on “Endogenous Climate Policy, stranded assets and systemic risk”.

The final presentation of the day was held by Alkis Blanz from the Mercator Research Institute on Global Commons and Climate Change and covered joint work with Beatriz Gaitan on “Differential Discounting, Climate Policy (and Housing) in General Equilibrium”.

The workshop made it abundantly clear that climate macroeconomics can offer highly relevant policy insights. Superficially, the economic answer to climate change tends to be simply putting a price on carbon equal to its social cost. A more thorough macroeconomic consideration of the challenges faced on climate policy suggests, however, that a more elaborate policy mix may be required. Stranded assets and financial market turbulences have to be avoided and green innovation fostered. The existence of a “brown” fossil equilibrium even in the presence of carbon pricing asks e.g. for green R&D subsidies, carbon prices above the social cost of carbon or the creation of a “brown bank” to isolate fossil investment risks. From the presentations and debates around these topics, the following three key take-aways can be condensed from the workshop:

1. Central banks can play a meaningful role in climate policy. The green transition brings substantial risks for financial stability making its management part of the central bank’s mandate.

2. Agents’ expectations matter strongly in the climate policy context. If market participants expect that fossil fuels continue to be used intensively and that brown investments will continue to play an important role, the economy can end up in a sub-optimal, high emission equilibrium, even though climate policies are taken that would be compatible with a green transition under different expectations.

3. A better understanding of a broader set of climate policies is necessary. Carbon pricing is an important tool for climate change mitigation, but potentially insufficient. Expectation management, R&D subsidies, public infrastructure investments and green financial market regulation are some of the additional policies identified. The way they work and interact with carbon pricing and with each other is a key area for future research.

A lot of work on environmental economics is done at several of the BSE institutions and the Berlin Climate Macro Workshop illustrated that opportunities for exchange between those researchers looking at environmental issues from a macroeconomic perspective creates large value-added.

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