Responding to climate change has become one of the world’s foremost policy challenges. In line with its mandate and expertise, the IMF is focused on the macroeconomic, fiscal, and financial challenges of climate change and related policies. The Fund’s activities in the area center on providing advice to member countries where climate change can have a significant impact on economic and financial stability. It also aims to promote understanding of the difficult issues of international fiscal policy cooperation confronting the efforts to design a successor to the Kyoto Protocol, building on progress made at the 2009 UN Climate Change Conference in Copenhagen. More recently, IMF staff has begun to contribute to the debate on how to finance responses to climate change in developing countries.

Macroeconomic challenges - A chapter in the Spring 2008 World Economic Outlook on climate change and the global economy sets out the macroeconomic challenges posed by climate change and policies to address the problem. It emphasizes that policies to mitigate climate change can have wide-ranging macroeconomic consequences.

The required establishment of a price on emissions of greenhouse gases would affect countries’ economic growth, saving and investment levels, capital flows, and exchange rates. Yet the chapter also reports simulation results that show how these costs can be minimized if policies are well designed. In particular, policies should be long-term and credible, yet flexible enough to be able to adjust to emerging information and changing economic conditions; and implemented as broadly as possible, while being managed so as to ensure an equitable distribution of costs.

Fiscal implications - A policy paper prepared for the Executive Board of the IMF deals in more detail with the fiscal implications of climate change. These take many forms. Climate change will directly affect tax bases and public spending needs, but beyond this there is also a more purposeful role for government tax and spending policies.

To mitigate climate change, fiscal instruments (emissions taxes, or cap-and-trade schemes to limit emission) are needed to ensure that the full social cost of greenhouse gas emissions is borne by emitters. However, while simple in principle, this raises substantial conceptual and implementation problems, requiring worldwide efforts and solutions.

Public expenditure on adaptation (learning to live with changing climatic conditions), may also be required to reduce societies’ risk exposure through better infrastructure, coastal protection, education, health and water services, and meet other challenges of changing climate. Such expenditure is expected to rise as climate change progresses and could reach more than US$100 billion annually, by 2030 or earlier.

In December 2009, IMF staff published a Staff Position Note, which evaluates the interactions between the key challenges of promoting more effective international cooperation on climate change while at the same time seeking to develop strategies to exit from the deepest economic crisis for decades.

The Fund continues to contribute to the fiscal policy debate relating to climate change, including as part of recent policy analysis on food and fuel price subsidies. In the case of fuel markets for example, reducing subsidies is a key first step towards more positive emissions pricing.

Financing responses to climate change - At the 2009 UN Climate Change Conference in Copenhagen, there was broad agreement that sustainable growth in developing countries will require large-scale, long-term investments for climate change adaptation and mitigation, and that substantial additional financial assistance is needed. Without a credible framework for providing this assistance, on the needed scale and on the right terms, there is a risk that developing countries’ responses to climate change will be either insufficient, thereby endangering sustainable growth, or inconsistent with maintaining fiscal and broader macroeconomic sustainability.

To contribute to the public debate on innovative ways of raising finance, IMF staff are developing an idea for a Green Fund with the capacity to raise the required resources, starting very soon. The Green Fund would give developed countries, which would need to contribute subsidy resources, the needed coordinating, commitment, and burden-sharing mechanism. The IMF would not play any role in creating or managing the Green Fund.

Implications for financial markets - Climate change has implications for financial markets. Innovative instruments—such as catastrophe bonds and weather derivatives—offer a way to manage some climate-related risks. These too are discussed in the 2008 World Economic Outlook chapter and the above-mentioned policy paper, and also in the March 2008 issue of Finance & Development, which contains several articles on macroeconomic aspects of climate change.

Other environmental work in the IMF - Though it has come to dominate the policy agenda, climate change is not the only environmental issue of potential macroeconomic significance. Others include: (i) local pollution; (ii) forest and other renewable resources; and (iii) the appropriate structure of environmental tax systems.

Some of these issues may interact with climate change (such as when reduced deforestation also leads to lower carbon emissions, and when less local pollution is associated with less burning of fossil fuels). However, to some degree, they are stand-alone issues which, when they become significant to macroeconomic performance, warrant IMF attention.