THOUGH our elected government may be in denial, the Reserve Bank – like other central banks – isn’t. Nor are the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission.
Please don’t think about climate change and the economy. It may upset you
Economics Editor November 2, 2019
It’s coming to something when we get so little leadership from the bloke we pay to lead us that the unelected have to fill the vacuum. Now 10 business organisations have united to urge Scott Morrison either to set out the climate policy rules to drive action by the private sector, or end up spending a shedload of taxpayers’ money fixing the problem himself.
It’s not just business that’s dissatisfied. The Morrison government may be dominated by climate-change deniers, but almost all economists accept the science of global warming and believe we should be doing our bit to help limit it.
And though our elected government may be in denial, the Reserve Bank – like other central banks – isn’t. Nor are the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission.
The Queensland Treasurer, Jackie Trad, asked federal Treasurer Josh Frydenberg if the Reserve’s deputy governor, Dr Guy Debelle, could be invited to talk about climate change and the economy at the recent meeting of treasurers, but Frydenberg declined.
So what was it Frydenberg didn’t want his fellow treasurers thinking about? Well, we can get a fair idea of what Debelle would have said from a speech he gave earlier this year.
But first, why do so many economists accept the science? Because they know very little about the science and so accept the advice of the experts, especially since there’s so much agreement between them.
And there’s another reason. Economists believe they can use their expertise to help the community make the changes we need to make with the least amount of cost and disruption to the economy.
As Debelle reminds us, “the economics profession has examined the effects of climate change at least since Nobel Prize winner William Nordhaus in 1977. Since then it has become an area of considerably more active research in the profession. There has been a large body of work around the appropriate design of policies to address climate change (such as the design of carbon pricing mechanisms), but not that much in terms of what it might imply for macro-economic policies” – that is, for efforts to stabilise the macro economy as it moves through the ups and downs of the business cycle.
Debelle says the economy is changing all the time in response to a large number of forces, but few of them have the scale, persistence and risk to the system that climate change has.
Macro economists like to classify the various “shocks” that hit the economy as either positive or negative and as hitting the demand side of the economy or the supply side. For instance, they know a positive demand shock increases production (gross domestic product) and prices. The monetary policy response to such a shock is obvious: you raise interest rates to ensure inflation doesn’t get out of hand.
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Shocks involving the climate affect the supply (output) side and are common. An unusually good growing season would be a positive supply shock, whereas a drought or cyclone or flood would be a negative supply shock, reducing output but increasing prices.
This is a trickier shock for monetary policy to respond to because it’s both contractionary (suggesting a cut in interest rates) and inflationary (suggesting higher rates). The Reserve’s usual response is to “look through” (ignore) the price increase, assuming its effect on inflation will be temporary.
Historically, the Reserve has assumed all climate events are temporary, with things soon returning to where they were. That is, they’re cyclical. It’s clear from the reports of the Intergovernmental Panel on Climate Change, however, that climate change is a trend – a lasting change in the structure of the economy, which will build up over many years.
Of course, though climate change’s impact on agriculture continues to be great, it presents significant risks and opportunities for a much broader part of the economy than agriculture.
Debelle says we need to reassess the frequency of climate events and our assumptions about the severity of those events. For example, the insurance industry has recognised that the frequency and severity of tropical cyclones has changed. It has “repriced” how it insures against such events.
Most of us are focused on “mitigating” – reducing – future climate change. But Debelle says we also need to think about how the economy is adapting to the climate change that’s already happened and how we’ll adapt to the further warming that’s coming, even if we do manage to get to zero net emissions before too long.
“The transition path to a less carbon-intensive world is clearly quite different depending on whether it is managed as a gradual process or is abrupt,” he says euphemistically. “The trend changes aren’t likely to be smooth. There is likely to be volatility around the trend, with the potential for damaging outcomes from spikes above the trend.”
Both the physical impact of climate change and the adjustment to a warmer world are likely to have significant economic effects, he says.
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Economists know from their experience with reducing protection that the change from the old arrangements to the new involves adjustment costs to some people (workers who have to find jobs in other industries, for instance) even if most people (consumers of the now-cheaper imports, for instance) are left better off.
Economists press on with advocating such painful changes provided they believe the gains to the winners are sufficient to allow them to compensate the losers and still be ahead. But Debelle admits that, in practice, the compensation to the losers doesn’t always happen, leaving those losers very dissatisfied.
That’s bad enough. But Debelle fears that, with climate change and the move to renewables, the distribution of benefits and costs may be such that the gains to the winners in new renewables industries aren’t great enough to cover the losses to the losers even in principle, let alone in practice.
*Nah, all too hard. Let’s just ignore it and hope it goes away.
Ross Gittins is the Herald’s economics editor.
Ross Gittins is the Economics Editor of The Sydney Morning Herald.