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Climate Resilience and the Adaptation Trap: A Macroeconomic Framework for Joint Fiscal–External Sustainability

Author

Listed:
  • António Afonso
  • José Alves
  • João Tovar Jalles
  • Sofia Monteiro

Abstract

Climate change is reshaping sovereign risk and macroeconomic stability by amplifying fiscal and external fragilities. This paper develops a unified framework to assess how climate vulnerability and resilience jointly influence fiscal–external solvency. We construct a market-based sustainability index that integrates time-varying fiscal and external reaction coefficients – estimated using Schlicht’s (2021) method-weighted by sovereign yields. Using a global panel of more than 60 economies (1981–2024), we document four key findings. First, structural vulnerability exerts a large and persistent drag on sustainability, even after controlling for macro fundamentals, as higher exposure magnifies expected losses and tightens financing conditions. Second, resilience does not display a strong unconditional effect but significantly mitigates the adverse impact of vulnerability, acting as a state-contingent stabilizer. Third, local projections with smooth transition (LP-STAR) reveal sharp nonlinearities: identical climate shocks trigger modest, short-lived effects in low-vulnerability or high-resilience regimes but cause deep and persistent deterioration when vulnerability is high and resilience weak. Fourth, these dynamics generate an “adaptation trap” – a self-reinforcing cycle where vulnerability raises yields, yields compress fiscal space, and limited adaptation perpetuates vulnerability. Policy implications are clear: resilience investment yields sizable macro-financial returns by reducing expected losses and compressing climate risk premia, while delaying adaptation risks entrenching fragility. Our results highlight the need to embed climate parameters into debt sustainability analyses and sovereign risk frameworks, particularly for emerging markets facing tighter financing constraints.

Suggested Citation

  • António Afonso & José Alves & João Tovar Jalles & Sofia Monteiro, 2026. "Climate Resilience and the Adaptation Trap: A Macroeconomic Framework for Joint Fiscal–External Sustainability," CESifo Working Paper Series 12389, CESifo.
  • Handle: RePEc:ces:ceswps:_12389
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    References listed on IDEAS

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    1. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(3), pages 823-866.
    2. Alberto Alesina & Filipe R. Campante & Guido Tabellini, 2008. "Why is Fiscal Policy Often Procyclical?," Journal of the European Economic Association, MIT Press, vol. 6(5), pages 1006-1036, September.
    3. António Afonso & José Alves & Tovar João Jalles & Sofia Monteiro & João Tovar Jalles, 2025. "Shaken Balances: Climate Risks and the Dynamics of Fiscal and External Sustainability," CESifo Working Paper Series 11818, CESifo.
    4. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
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    Keywords

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    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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