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The Carbon Bubble: Climate Policy in a Fire-sale Model of Deleveraging

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  • Alessandro Spiganti

    (University of Edinburgh)

  • David Comerford

    (University of Strathclyde)

Abstract

Committed and credible implementation of climate change policy, consistent with the usual 2C limit, is thought to require large fossil fuel asset write-offs. This issue, termed the Carbon Bubble, is usually presented as having implications for investors but, for the first time, this paper discusses its implications for macroeconomic policy and for climate policy itself. We embed the Carbon Bubble in a macroeconomic model exhibiting a financial accelerator: if investors are leveraged, the Carbon Bubble may precipitate a fire-sale as investors rush for the exits, and generate a large and persistent fall in output and investment. We investigate policy responses which can accompany the writing-off of fossil fuel assets, like debt transfers, investment subsidies, government guarantees, or even deception about the true scale of the required write-off of fossil fuel assets. We find a role for policy in mitigating the Carbon Bubble.

Suggested Citation

  • Alessandro Spiganti & David Comerford, 2017. "The Carbon Bubble: Climate Policy in a Fire-sale Model of Deleveraging," 2017 Meeting Papers 734, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:734
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    File URL: https://economicdynamics.org/meetpapers/2017/paper_734.pdf
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    References listed on IDEAS

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    1. Michael B Devereux & James Yetman, 2010. "Financial deleveraging and the international transmission of shocks," BIS Papers chapters,in: Bank for International Settlements (ed.), The international financial crisis and policy challenges in Asia and the Pacific, volume 52, pages 274-298 Bank for International Settlements.
    2. Punzi, Maria Teresa & Rabitsch, Katrin, 2015. "Investor borrowing heterogeneity in a Kiyotaki–Moore style macro model," Economics Letters, Elsevier, vol. 130(C), pages 75-79.
    3. Hans Gersbach & Jean‐Charles Rochet, 2012. "Aggregate Investment Externalities and Macroprudential Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44, pages 73-109, December.
    4. Claudia Ghisetti & Massimiliano Mazzanti & Susanna Mancinelli & Mariangela Zoli, 2015. "Do financial constraints make the environment worse off? Understanding the effects of financial barriers on environmental innovations," SEEDS Working Papers 0115, SEEDS, Sustainability Environmental Economics and Dynamics Studies, revised Jan 2015.
    5. Richard G. Newell & Yifei Qian & Daniel Raimi, 2016. "Global Energy Outlook 2015," NBER Working Papers 22075, National Bureau of Economic Research, Inc.
    6. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 841-879.
    7. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 17-34.
    8. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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