The International Monetary Fund (IMF) and climate change do not often appear in the same headline together. Indeed, environmental issues have been, at most, peripheral to the Fund's core functions. But now economists inside and outside the IMF are beginning to understand that climate change has significant implications for national and regional economies, and so it's worth reconsidering the Fund's role in addressing the climate challenge.
To her credit, Managing Director Christine Lagarde has boldly injected the IMF's voice into the global debate on policy responses to climate change and has identified a number of roles the Fund can play.
The Fund has conducted valuable work on how carbon emissions can be reduced through market prices that reflect the negative externalities of those emissions. In particular, the Fund has become a leading voice for quantifying and streamlining or eliminating fossil fuel subsidies, as well as for introducing carbon-pricing mechanisms.
What is still missing, however, is a bigger role for the IMF in enabling countries to prepare and manage the potential impacts of climate change. There are three things the Fund could do, building on its current efforts, that would make a big difference:
1. Deepen Research on Macroeconomic and Financial Impacts of Climate Change
In a climate change debate that has become heavily politicized, the Fund's technical and nonpartisan voice is uniquely valuable. Few questions are as important as understanding the possible effects of a changing climate on the world's economies, especially the most vulnerable ones.
The Fund has recently started to make important contributions in this area. In a paper published last year, the IMF started to look into the implications of climate change on so-called "small states". And last week, the Fund devoted for the first time a whole chapter of its flagship World Economic Outlook to the impacts of weather shocks on economic activity.
Building on these foundations, the Fund should focus its research capabilities on a key question, namely whether climate change is having have a “level effect” or a “growth effect” on per capita income. If the former, then climate change will only destroy a given amount of income over time (think of damaged bridges and buildings) but not affect the capacity of the economy itself to grow. If the latter, then climate change is also harming the drivers of growth themselves, such as the productivity and availability of workers, the productivity of agriculture, and the flow of investment. The economy’s growth rate will slow as a result, and losses will compound year after year, leaving an economy significantly worse off than if only level effects applied.
Getting better answers to this question is essential for policymakers making decisions about how much to spend today to avoid damage tomorrow.
2. Formally Incorporate Climate Change Into Policy Dialogue
One of the Fund’s core functions is macroeconomic surveillance. This function brings Fund staff into regular policy dialogues (called Article IV consultations) with financial authorities in virtually every country in the world.
Financial authorities have a key role to play in preparing for climate change, as they are charged with budget planning and managing fiscal and financial risks. The Fund should bring climate risk into the dialogue as a formal part of its consultations, not just with small states, but with a much larger set of vulnerable countries as well, including systemically-significant ones.
The Seychelles. Flickr/Federico Robertazzi
This year, in collaboration with the World Bank, the Fund launched the first Climate Change Policy Assessment (CCPA) during the Article IV consultations for the Seychelles. The assessment focused on policy options to reduce vulnerability to climate change; the Seychelle authorities found it to be very useful. More CCPAs are planned – a small handful per year – but this is simply not fast enough given the urgency and gravity of the challenge.
The Fund should formalize CCPAs as a routine part of Article IV consultations for a broad swath of vulnerable, low-income countries. This will require investing in staff capacity and training, including in the Fund’s Monetary and Capital Markets Department, which can help countries identify how climate risks and opportunities could affect their financial systems. Maximizing synergies with the World Bank on the CCPAs will also be necessary.
3. Treat Expenditures on Climate Resilience as Investments
Countries facing a balance-of-payments crisis often draw on IMF resources and enter into a program relationship with the IMF. One of the trickiest elements when negotiating such a program is how to treat different categories of spending and where to cut to restore fiscal balance. How should the Fund treat expenditures designed to provide financial protection against extreme weather events? These include, for example, deposits into a national reserve fund, premium payments on sovereign insurance against natural disasters, or the costs of issuing catastrophe (“cat”) bonds.
Protecting some of these expenditures from program-mandated cuts is fully appropriate, as they are designed to provide a measure of fiscal protection to the government in the aftermath of an extreme weather event. For instance, the Fund might treat cat bond issuance costs and insurance premiums as investments with potential upside, rather than as expenditures, thereby exempting them from cuts.
Managing Director Lagarde has positioned the IMF as an important and credible voice in the debate about climate change. Now it’s time for the Fund to expand and institutionalize this new role, helping poor and vulnerable countries understand and confront the macroeconomic and financial risks of climate change.