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© 2022 International Monetary Fund
WP/22/189
IMF Working Paper
Strategy, Policy, and Review Department
Stress Testing the Global Economy to Climate Change-Related Shocks in Large and Interconnected Economies1
Prepared by Yeu Jin Jung, Camilo E. Tovar, Yiqun Wu, and Tianxiao Zheng
Authorized for distribution by Delia Velculescu
September 2022
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: We stress test the global economy to extreme climate change-related shocks on large and interconnected economies. Our analysis (i) identifies large and interconnected economies vulnerable to climate change-related shocks; (ii) estimates these economies’ external financing needs-at-risk due to these shocks, and (iii) quantifies the spillovers to the global economy using a global network model. We show that large and interconnected economies vulnerable to climate change could trigger a drain of $1.8 trillion in international reserves (2 percent of 2019’s global GDP). Domestic and multilateral macroeconomic policies can help reduce these global lossess to about $0.8 trillion. The scenario highlights the importance of considering global spillovers when assessing the impact of climate change-related shocks.
| JEL Classification Numbers: | F34, F37, F41, F47, F60, F65, F68, G15, G17, Q54 |
| Keywords: | Climate change; external financing-needs-at-risk; multilayered networks |
| Author’s E-Mail Address: | yeujin.jung@gmail.com; ctovar@imf.org (Corresponding author); ywu2@imf.org; tzheng@imf.org. |
| JEL Classification Numbers: | F34, F37, F41, F47, F60, F65, F68, G15, G17, Q54 |
| Keywords: | Climate change; external financing-needs-at-risk; multilayered networks |
| Author’s E-Mail Address: | yeujin.jung@gmail.com; ctovar@imf.org (Corresponding author); ywu2@imf.org; tzheng@imf.org. |
Title Page
WORKING PAPERS
Stress Testing the Global Economy to Climate Change-Related Shocks in Large Interconnected Economies
Prepared by Yeu Jin Jung, Camilo E. Tovar, Yiqun Wu, and Tianxiao Zheng
Contents
I. Introduction
II. Literature Review
A. Macroeconomic Impact of Climate Change
B. Policy Responses and Trade-offs
C. Interconnectedness, Spillovers, and Contagion
III. Vulnerability to Climate Change
A. Definitions
B. Measures of Climate Change Vulnerability
C. Identify Vulnerable Economies to Climate Change
IV. Climate Change and External Financing Needs-at-Risk
A. Econometric Results
V. Stress Testing the Global Economy to Climate Change-Related Shocks
A. Simulations Scenario Using the Multilayered Network Model
VI. Conclusion and Policy Implications
References
FIGURES
1. Economic Size, Interconnectedness, and Climate Change Vulnerability
2. Global Value Chains (GVCs) and Climate Vulnerability
3. External Financing Needs-at-Risk (F@R): Density Estimates for Baseline and Climate Change-Related Shock Scenarios
4. CDS Spreads and Climate Change Vulnerability
5. CDS Spreads and Reserve Adequacy Levels
6. Extreme Scenario: Global Systemic Impact of a Combined Climate Change-Related Shock in Country A and Country B
TABLE
1. Assessing Country Vulnerabilities to Climate Change Risks
ANNEXES
I. Data Source
II. Robustness Check
III. External Financing Needs-at-Risk Quantile Regressions
IV. Multilayered Network Model
We thank Ana Corbacho, Kristina Kostial, and Delia Velculescu for their comments, support, and continued encouragement to pursue this project. We also acknowledge very useful discussions with Juan Trevino, Pilar Garcia-Martinez, and Dragana Ostojic, and the outstanding research assistance of Ethan Boswell, Nick Hallmark, Shiming Xiong, and Yuchen Zhang. Finally, we thank seminar participants at SPR’s Strategy Unit for their feedback.