NiGEM Topical Feature: Short-term Impact from a Rapid Increase in Carbon Taxes

Greenhouse gas emissions are expected to continue to increase unless there is a significant shift in human behaviour, including a considerable change in the energy mix, towards low carbon and no-carbon sources. The NGFS3 scenarios have been widely used to illustrate possible long-term economic impacts from climate-related changes. Recently, analysis of the short-term economic impact from climate change and related policies has gained interest, because, when considering the implications for financial stability and financial institutions, investigating short-term risks is critically important. In this NiGEM Topical Feature, we evaluate the short-term impacts from climate-related changes by examining a hypothetical scenario using the climate module of NIGEM. In our scenario, an increase in carbon taxes would be expected to lower GDP growth across a wide range of countries by about 1 - 3 percentage points relative to 'current policies', which is smaller than the losses observed during the global financial crisis (GFC) or the first year of the Covid-19 pandemic. The sudden carbon tax rise is expected to disturb the financial markets and push real interest rates up and asset values down. Based on our hypothetical scenario, asset prices fall by up to 20 per cent initially, which is 2 or 3 times smaller than the reductions observed during the GFC. The carbon tax will generate fiscal revenue, which in our analysis is allowed to reduce household income tax rates, thus partially offsetting the negative consequences of the higher carbon tax rates.