In the past decade the global economy has struggled to produce sustained economic growth. While the financial crisis of 2007-2009 and the Great Recession left a lasting impact on companies and decision-makers, the structural changes to the economy since then have been substantial.
Companies have adapted by changing the employment structure of how they operate. Many companies, to cut costs, have changed many jobs from w2 positions to contractor or out sourced positions. This has allowed large companies to pay less in terms of benefits to their workers; benefits such as health insurance, disability insurance, life insurance and retirement savings.
In the past five years, improvements around technology, and specifically AI (Artificial Intelligence) has led to greater efficiencies for companies while allowing them to shed unnecessary workers. As the use of AI expands throughout the economy and as applications multiply, millions of jobs are expected to be impacted. (1)
The Great Recession had a devastating impact on many aging workers who found their nest egg impacted and their dreams of retirement deferred. Labor department statistics indicate that 10,000 workers are due to retire each day for the next twenty years. Many of these baby boomer workers are finding that they are having to work longer due to the financial impact of the crisis in 2007.
In addition, companies have been slow to raise income growth for workers, creating for many employees a race to the bottom with low salaries and compensation. A large portion of American workers do not have adequate savings in case of emergencies. Many workers, even though they work full time, are still dependent upon food stamps and community food banks in order to survive.
All of these conditions have worsened considerably since the financial crisis of 2007 and are a result of companies feeling constricted and hamstrung by a low-growth environment.
The issues around low growth are outlined in a 2016 report by the OECD (Organisation for Economic Co-operation and Development).
“Growth is flat in the advanced economies and has slowed in many of the emerging economies that have been the global locomotive since the crisis… Slower productivity growth and rising inequality pose further challenges. Comprehensive policy action is urgently needed to ensure that we get off this disappointing growth path and propel our economies to levels that will safeguard living standards for all,”
Growth has continued in the 2.5%-3% range for the past decade. This is low based on historical comparisons. In addition, recent reports in the second quarter of 2019 indicate a further slowing in the global economy. (2)
The report calls for a more comprehensive use of fiscal policy and revived structural reforms to break out of the low-growth trap. (3)
But what if the cause of the lack of global growth is something more fundamental and complex? What if we are seeing a change in the economic system itself, due to Climate Change…
In March of 2019 the Federal Reserve Bank of San Francisco issued a research note that addresses these changes. (4) The Federal Reserve is one of the most important and financially responsible agencies in the United States, as well as the world. The primary task of the Fed is to promote full employment and to manage inflation.
In a report titled “Climate Change and the Federal Reserve”, the authors describe “three key forces (that) are transforming the economy: a demographic shift toward an older population, rapid advances in technology, and climate change.” This is a huge change in policy direction by the single most important financial body in the world, recognizing the importance of Climate Change. The report states, “Climate change has direct effects on the economy resulting from various environmental shifts, including hotter temperatures, rising sea levels, and more frequent and extreme storms, floods, and droughts. It also has indirect effects resulting from attempts to adapt to these new conditions and from efforts to limit or mitigate climate change through a transition to a low-carbon economy.”
The report connects the dots between Climate Change, economic growth (or lack thereof), planning and policy creation.
“Climate change also affects the U.S. economy. The latest National Climate Assessment, a 1,515-page scientific report produced by 13 federal agencies as required by law, summarized this impact: Without substantial and sustained global mitigation and regional adaptation efforts, climate change is expected to cause growing losses to American infrastructure and property and impede the rate of economic growth over this century (USGCRP 2018, pp. 25–26).”
The report connects this impeded growth directly to the failed pricing model of cheap carbon…
“Economists view these losses as the result of a fundamental market failure: carbon fuel prices do not properly account for climate change costs. Businesses and households that produce greenhouse gas emissions, say, by driving cars or generating electricity, do not pay for the losses and damage caused by that pollution. Therefore, they have no direct incentive to switch to a low-carbon technology that would curtail emissions. Without proper price signals and incentives in the private market, some kind of collective or government action is necessary. One solution would be to charge for the full cost of carbon pollution through an extra fee on emissions—a carbon tax—that would account for the costs of climate change on the economy and society. Many leading economists are calling for a carbon tax to correct market pricing (Climate Leadership Council 2019, Fried, Novan, and Peterman 2019).”
The report goes on to call for a carbon tax that includes the total, long term impact of carbon…
“Such a carbon tax should equal the “social cost of carbon,” which measures the total damage from an additional ton of carbon pollution (“Quantifying Economic Damages from Climate Change”, Auffhammer 2018). A crucial consideration in calculating this cost is that carbon pollution dissipates very slowly and will remain in the atmosphere for centuries, redirecting heat back toward the earth. Consequently, today’s carbon pollution will create climate hazards for many generations to come.”
The report asks, “Given the role of government in addressing climate change, how does the Federal Reserve fit in?”
“With regard to financial stability, many central banks have acknowledged the importance of accounting for the increasing financial risks from climate change (“The Bank of England’s Response to Climate Change”, Scott, van Huizen, and Jung 2017, NGFS 2018). These risks include potential loan losses at banks resulting from the business interruptions and bankruptcies caused by storms, droughts, wildfires, and other extreme events. There are also transition risks associated with the adjustment to a low-carbon economy, such as the unexpected losses in the value of assets or companies that (FRBSF Economic Letter 2019-09 March 25, 2019) depend on fossil fuels. In this regard, even long-term risks can have near-term consequences as investors reprice assets for a low-carbon future (ie. “sunken assets”). Furthermore, financial firms with limited carbon emissions may still face substantial climate-based credit risk exposure, for example, through loans to affected businesses or mortgages on coastal real estate. If such exposures were broadly correlated across regions or industries, the resulting climate-based risk could threaten the stability of the financial system as a whole and be of macroprudential concern. In response, the financial supervisory authorities in a number of countries have encouraged financial institutions to disclose any climate-related financial risks and to conduct “climate stress tests” to assess their solvency across a range of future climate change alternatives (“Climate Change Challenges for Central Banks and Financial Regulators”, Campiglio et al. 2018).”
Climate stress tests can help investors and decision makers better allocate capital to protect against risk of loss and assist in long term planning while transitioning to a clean economy.
Several central banks have concluded that climate change will directly affect monetary policy…
“For example, climate-related financial risks could affect the economy through elevated credit spreads, greater precautionary saving, and, in the extreme, a financial crisis. There could also be direct effects in the form of larger and more frequent macroeconomic shocks associated with the infrastructure damage, agricultural losses, and commodity price spikes caused by the droughts, floods, and hurricanes amplified by climate change (“Climate Change and the Economy”, Debelle 2019). Even weather disasters abroad can disrupt exports, imports, and supply chains close to home. As a much more persistent factor, Colacito et al. (“The Impact of Higher Temperatures on
Economic Growth”, 2018) found that the current trend toward higher temperatures on its own has slowed growth in a variety of sectors. They estimated that increased warming has already started to reduce average U.S. output growth…”
“…increased warming has already started to reduce average U.S. output growth…”
This has been my belief for several years and it is now confirmed by the Federal Reserve.
Another impact on growth is the need to divert valuable resources away from productive activities…
“On top of these direct effects, climate adaptation—with spending on equipment such as air conditioners and resilient infrastructure including seawalls and fortified transportation systems—is expected to increasingly divert resources from productive capital accumulation.”
“In short, climate change is becoming relevant for a range of macroeconomic issues, including potential output growth, capital formation, productivity, and the long-run level of the real interest rate.”
How does this relate to the Fed’s borrowing and lending ability?
“While the effects and risks of climate change are relevant factors for the Fed to consider, the Fed is not in a position to use monetary policy actively to foster a transition to a low-carbon economy. Supporting environmental sustainability and limiting climate change are not directly included in the Fed’s statutory mandate of price stability and full employment. Furthermore, the Fed’s short-term interest rate policy tool is not amenable to supporting low-carbon industries. Wind farms in Kansas and coal mines in West Virginia face the same underlying risk-free short-term interest rate. Instead, some have advocated that central banks use their balance sheet to support the transition to a low-carbon economy, for example, by buying low-carbon corporate bonds (“Is Climate Change Relevant for Central Banks?”, Olovsson 2018). Such “green” quantitative easing is an option for some central banks but not for the Fed, which by law can only purchase government or government agency debt.”
That being said, Congress has the ability to give the Fed the ability to purchase assets as they did when Congress enacted TARP during the financial crisis. Congress also has the ability to finance the transition to a low-carbon economy by issuing long term (100 year-300 year debt) low yield “Green Bonds” which the Fed could hold.
The UN Panel of Climate Change issued a warning in October of 2018 that we collectively as a species have 12 years to reverse course and avoid a worst case scenario. A substantial and long term increase in temperatures is assumed based on CO2 and other GhGs that have already been released and based on the current glide path of expected pollutant releases.
It is clear that the Federal Reserve and other central banks are already integrating the dynamics of Climate Change into their formulation of policy, but clearly much more needs to be done in the months and years to come.
If you have questions regarding Climate Change and its impact on your financial future please feel free to email me at email@example.com
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