Climate Policies and External Adjustment

IMF Working Papers, July 26, 2024

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Assesses the economic effects of climate policies on different regions and countries with a focus on external adjustment.
Emphasizes differences in external balance impacts across policy types and country characteristics.
Notes dependence of outcomes on international policy coordination and credibility.

Various climate policies could have substantially different impacts on external balances over the next decade.
A credible and globally coordinated carbon tax would:
- Decrease current account balances in greener advanced economies.
- Increase current accounts in more fossil-fuel-dependent regions.
- Reflect a disproportionate decline in investment for fossil-fuel-dependent regions.
Green supply-side policies (green subsidy and infrastructure investment) would:
- Increase investment and saving.
- Have a more muted external sector impact because of the constrained pace of expansion for renewables or the symmetry of the infrastructure boost.
Country characteristics ultimately determine current account responses, notably:
- Initial carbon intensity.
- Net fossil fuel exports.
For the global economy, a coordinated climate change mitigation policy package would shift capital towards advanced economies.
Global interest rates would:
- Rise initially.
- Fall over time with increases in the carbon tax.
These external sector effects depend crucially on the degree of international policy coordination and credibility.

Carbon tax channel:
- Alters relative returns across sectors and regions.
- Drives differential investment responses, especially reducing investment in fossil-fuel-dependent regions.
Green supply-side channel:
- Directly increases investment and saving via subsidies and infrastructure spending.
- External impact muted by physical constraints on renewable expansion and symmetric infrastructure effects.
Country heterogeneity channel:
- Initial carbon intensity and net fuel export status condition the magnitude and sign of current account responses.
International capital flows:
- Coordinated mitigation shifts capital towards advanced economies.

International coordination and credibility are central to the external sector outcomes of climate policy.
Policymakers should consider country-specific characteristics (initial carbon intensity, net fossil fuel exports) when designing mitigation packages to anticipate external adjustment needs.
Green supply-side measures can boost investment and saving but may not produce large external balance effects in the near term due to implementation and physical constraints.
Carbon pricing implemented credibly and globally will redistribute external balances across regions and influence global interest rates over time.

Climate Policies and External Adjustment, IMF Working Paper No. 2024/162