Public Debt Dynamics During the Climate Transition

IMF Working Papers, March 29, 2024

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Managing the climate transition presents policymakers with a tradeoff between achieving climate goals, fiscal sustainability, and political feasibility, which calls for a fiscal balancing act with the right mix of policies.
The paper develops a tractable dynamic general equilibrium model to quantify the fiscal impacts of various climate policy packages aimed at reaching net zero emissions by mid-century.
Simulations compare policy mixes focused primarily on spending with mixes that include carbon-pricing and spending-based policies.

Relying primarily on spending measures to deliver on climate ambitions will be costly, possibly raising debt by 45-50 percent of GDP by 2050.
A balanced mix of carbon-pricing and spending-based policies can deliver on net zero with a much smaller fiscal cost, limiting the increase in public debt to 10-15 percent of GDP by 2050.
Carbon pricing is central as an effective tool for emissions reduction and as a revenue source.
Delaying carbon pricing action could increase costs, especially if less effective measures are scaled up to meet climate targets.
Technology spillovers can reduce the costs of the transition.
Bottlenecks in green investment could unwind the gains from technology spillovers and slow the transition.

Framework: Tractable dynamic general equilibrium model.
Policy objectives: Reach net zero emissions by mid-century.
Policy packages evaluated: Spending-dominant approaches; balanced mixes combining carbon pricing and spending; delayed carbon-pricing implementation; scenarios with technology spillovers and with green investment bottlenecks.

Prioritize a balanced policy mix that includes carbon pricing alongside targeted spending to limit fiscal costs while achieving climate goals.
Implement carbon pricing early to harness both emissions reductions and revenue generation, avoiding higher costs from scaling up less effective measures later.
Support policies that enable technology spillovers to lower transition costs.
Address potential bottlenecks in green investment to prevent loss of gains and slowdowns in the transition.