Annex I. The Legal Framework for Article IV Consultations as it Pertains to the Coverage of Climate Change1
1. Many policies that are key for addressing climate change fall within the Fund’s surveillance remit. While the Fund is not an environmental agency and its mandate does not include the protection of the environment per se, many aspects of climate change pertain to its mandate: for example, the effects of climate policies on domestic economic and financial performance, and the impact of climate change on global economic and financial stability. Such issues are relevant for the Fund’s bilateral and multilateral surveillance.
2. Bilateral surveillance requires the Fund to oversee the compliance of each member with its obligations under Article IV, Section 1.2 Members have an obligation to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates; and in particular: (i) to endeavor to direct economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to their circumstances; and (ii) to seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions. In its bilateral surveillance, the Fund assesses whether a member’s exchange rate and other economic and financial policies promote the member’s own domestic and BOP stability. The legal framework for bilateral surveillance under Article IV is specified in greater detail in the Integrated Surveillance Decision (ISD).3
3. In this context, there are three channels whereby discussion is mandatory, each with relevance for climate change.
First, the ISD provides that the macroeconomic and macroeconomically relevant structural aspects of monetary, fiscal and financial sector policies will always be covered.4 Therefore, where such policies are being implemented or proposed and relate to climate change, they should be discussed.
Second, other policies must be discussed if they significantly influence present or prospective balance of payments or domestic stability.5 This can include, for example, structural policies related to climate change that have stability implications. This determination of macro-criticality is country-specific.
Third, Article IV consultations should assess “inward spillovers,” i.e., the actual or potential impact of global developments and policy actions in other countries on a member’s economic and financial stability, as well as the appropriate policy response.6 Many adaptation challenges—e.g., to rising sea levels that require investment in infrastructure—can be considered a consequence of inward spillovers. Transition risks can also be triggered by inward spillovers, such as changes in energy prices due to mitigation action by other countries.
4. Multilateral surveillance requires the Fund to oversee the international monetary system (IMS) to ensure its effective operation.7 While members obligations on the conduct of their exchange rate and other economic and financial policies are limited to the promotion of their own domestic balance of payment stability, members must consult with the Fund on issues pertaining to multilateral surveillance and provide information requested for that purpose. Recognizing that members’ policies may have a significant impact on other members and on global economic and financial stability, the Fund encourages members to implement exchange rate and domestic economic and financial policies that, in themselves or in combination with the policies of other members, are conductive of the effective operation of the international monetary system.8 Further, in its multilateral surveillance the Fund will focus on issues that may affect the effective operation of the international monetary system, including the spillovers from policies of individual members that may significantly influence the effective operation of the international monetary system, for example by undermining global economic and financial stability. A member’s policies that may be relevant for this purpose include exchange rate, monetary, fiscal, and financial sector policies, as well as polices respecting capital flows.
5. As Article IV consultations are a vehicle for both bilateral and multilateral surveillance, the ISD provides scope to discuss spillovers from climate related economic and financial policies in these consultations. In particular, Article IV consultations “shall include a discussion of the spillover effects of a member’s exchange rate and domestic economic and financial policies that may significantly influence the effective operation of the international monetary system, for example, by undermining global economic and financial stability”.9 In such a case, the Fund may “discuss the impact of a members’ policies on the effective operation of the IMS and may suggest alternative policies that, while promoting the member’s own stability, better promote the effective operation of the IMS.”10 Climate mitigation economic policies—or the lack thereof—would fall under this provision where they meet this standard.
6. Even if important climate-related policies fall outside of the parameters of bilateral and multilateral surveillance, it is legally possible to discuss them in an Article IV consultation with the agreement of the relevant member. While the surveillance framework defines the scope of issues that members are required to discuss with the Fund under Article IV, it is also possible for members to voluntarily agree to discuss other issues with the Fund in an Article IV consultation. The Fund’s policy advice on these issues would be technical assistance under Article V, Section 2 (b) and not surveillance but could be included in the member’s Article IV consultation report.
Annex II. The Detrimental Impact of Climate Change on Growth and Macroeconomic Stability1
1. Climate change can have significant detrimental effects on macroeconomic stability acting through several environmental pathways, including rising global temperatures; greater frequency and intensity of natural disasters; rising sea levels and ocean acidification; changes in precipitation (weather patterns); and impacts on biodiversity. The economic pathways include lower productivity in agriculture and fishing, and due to the effect of hotter temperatures on outside work, more frequent disruption of activity and destruction of productive capital due to weather events and natural disasters, diversion of resources towards adaptation and reconstruction, increased morbidity and mortality due to more prevalent infectious diseases and natural disasters, increased climate-related migration pressures and risk of conflict, and the potential for catastrophic losses related to changes in ocean currents and key weather patterns such as monsoons.
2. Estimates of the economic cost of climate change are subject to a high degree of uncertainty, as the pace of increase in temperatures is unprecedented compared to the last 20,000 years, and temperatures could rise to levels that have not been seen in millions of years. Uncertainties also arise due to the mitigating effects of endogenous policy responses on the one hand, and amplifying effects due to potential non-linear climate shifts on the other.
3. There is broad agreement in the literature that the effect of rising temperatures on the level of GDP are non-linear. An increase in temperature raises GDP in countries where annual average temperatures are low, but reduces GDP where they are high. The tipping point is at an average temperature of about 13-15°C.2 IMF estimates suggest that a temperature increase of 1°C in low-income countries lowers growth in the same year by 1.2 percentage points (IMF, 2017). While these historical estimates point to more moderate (or in some cases, positive) effects for colder regions, these do not include a number of damages (for example, rise in sea levels, natural disasters, damage to infrastructure from thawing of permafrost in Russia) and negative global spillovers from large economic disruptions in other parts of the world.
4. Further, some estimates also suggest an additional impact of rising temperatures on growth (e.g., Burke and others 2015), though this is open to debate. This would result in much larger GDP losses over the long term. In the absence of climate mitigation policies, losses in GDP could be of the order of 25 percent by 2100 relative to holding temperatures fixed at current levels (Figure).3
5. The fact that global warming has negative economic effects above 13–15° C matters for low-income countries, as many of them are in hotter parts of the world. These are also countries which are more vulnerable, as they have less resources to invest in adaptation and resilience.4 Some estimates set output losses under unmitigated climate change at 60–80 percent by 2100 for hot-climate countries.
6. Moreover, there is the prospect of more frequent and intense weather events and natural disasters with unchecked climate change.5 Low-income countries are more vulnerable to such events, which could reduce per capita income by 1.5 percentage points (compared to smaller, even negligible effects in emerging and advanced economies). Countries more prone to natural disasters may also experience slower convergence than less vulnerable countries.6
7. A major source of uncertainty in assessing the damages from climate change is around “tipping points.” If critical environmental thresholds are crossed, this could lead to rapid locking-in of a new climatic state, with potentially devastating consequences. These types of situations are not currently factored into climate damage assessments. To give an example, melting of the Antarctic and Greenland ice-sheets would be a tipping element, as their melting could quickly become irreversible and lead to sea levels rising by several meters. The thawing of the permafrost is another potential tipping element, as it could release large quantities of CO2 and methane currently locked away under the ice into the atmosphere, triggering a runaway greenhouse effect. Other tipping points include melting of the Himalayan glacier, change in monsoon patterns, and weakening or reversal of ocean currents.
Burke, Marshall, Marshall, Solomon M. Hsiang and Edward Miguel (2015): “Global Non-Linear Effect of Temperature on Economic Production,” Nature, Vol. 527, pp. 235–239.
Cantelmo, Alessandro, Giovanni Melina and Chris Papageorgiou: “Macroeconomic Outcomes in Disaster-Prone Countries,” IMF Working Paper 19/217.
Dell, Melissa, Benjamin F. Jones and Benjamin A. Olken (2014): “What Do We Learn from the Weather? The New Climate-Economy Literature,” Journal of Economic Literature Vol. 52(3), pp. 740-98.
Hassler, John, Per Krusell and Conny Olovsson (2018): “The Consequences of Uncertainty: Climate Sensitivity and Economic Sensitivity to the Climate,” Annual Review of Economics Vol. 10, pp 189–205.
Heal, Geoffrey and Jisung Park (2016): “Reflections—Temperature Stress and the Direct Impact of Climate Change: A Review of an Emerging Literature,” Review of Environmental Economics and Policy, Vol. 10 (2), pp. 347–362.
IMF (2017): “The Effects of Weather Shocks on Economic Activity: How Can Low-Income Countries Cope?”, World Economic Outlook, Chapter 3, October 2017.
Klenert, David, Linus Mattauch, Emmanuel Combet, Ottmar Edenhofer, Cameron Hepburn, Ryan Rafaty and Nicholas Stern (2018): “Making Carbon Pricing Work for Citizens,” Nature Climate Change Vol. 8, pp. 669–677.
Nordhaus, William D (2010): “Excel file for RICE model as of April 26, 2010,” Ann Arbor, MI: Interuniversity Consortium for Political and Social Research [distributor], https://doi.org/10.3886/ICPSR28461.v1.
The IMF’s policy advice on these issues is in the legal sense technical assistance rather than surveillance, but can be included in the member’s Article IV consultation report.
Put differently, climate change mitigation is a global public good. As with other public goods, mitigation will be undersupplied in the absence of an effective coordination and enforcement mechanism.
Mitigation and domestic transition management are related and the dividing line between them can be somewhat blurry. As discussed above, for the purpose of categorizing climate-related policies in the context of IMF surveillance it is helpful to distinguish between domestic policies on the one hand, and policies with a global/cross-border component on the other—such as containing negative spillovers and/or contributing to the provision of a global public good. In line with this categorization, policies to achieve a given domestic target (such as an NDC) are discussed here under “transition management”, while “mitigation” covers a country’s contribution to the global climate change mitigation effort. An implication is that measures well-suited to achieve a country’s NDC may not result in an adequate mitigation policy if the NDC itself is insufficient (see the discussion below). In practice, Article IV reports will typically discuss mitigation and transition management as a package.
This principle—developed countries are to provide financial resources to assist developing countries with achieving their climate objectives—is also inscribed into the Paris agreement.
Per-capital emissions are also sometimes suggested as an indicator to reflect equity considerations.
In contrast to backward or forward-looking metrics, current emissions can be observed without requiring elaborate estimates or assumptions. Current emissions also ‘compromise’ between the metrics discussed above and the various considerations that speak in their favor.
At present the list includes China, the United States, the European Union (to be covered in the report on common Euro area policies in the context of Article IV consultations with member countries), India, Russia, Japan, Brazil, Indonesia, Canada, Mexico, Iran, Korea, Australia, Saudi Arabia, the United Kingdom, South Africa, Turkey, Ukraine, Thailand, and Argentina. Within the European Union, the Article IV reports for Germany, France, Italy and Poland should also cover climate change mitigation (as they cross the “top 20” threshold when assessed on their own). Even though the IMF’s Article IV surveillance mandate pertains to individual members, covering mitigation in the report on common Euro area policies suggests itself, as many aspects of the members’ mitigation policies are determined at the European level.
It can also be an otherwise defined domestic policy target, in particular when the latter is more recent than the NDC. In the rare case where a country does not have an NDC, a global yardstick implied by the Paris objectives may have to be used (not NDCs): measures equivalent to an average carbon price of US$75 per ton in 2030 (IMF, 2019) and/or Net Carbon Neutrality by 2050. However, this question will require further elaboration should such a case arise.
A possible explanation is that confidence in governments to implement re-distributional policies is a prerequisite for making carbon pricing politically acceptable—where such confidence is lacking, carbon pricing thus risks running into political economy constraints.
ISD ¶9 stipulates: “in the context of multilateral surveillance, the Fund may not and will not require a member to change its policies in the interests of the effective operation of the international monetary system. It may, however, discuss the impact of members’ policies on the effective operation of the international monetary system and may suggest alternative policies that, while promoting the member’s own stability, better promote the effective operation of the international monetary system.”
Prepared by Julianne Ams and Nadia Rendak (LEG).
Article IV, Section 1and Section 3(a). Members also have obligations on the conduct of their exchange rate policies.
Decision No. 15203-(12/72), adopted July 18, 2012.
ISD para. 6: “In its bilateral surveillance, the Fund will focus on those policies that can significantly influence present or prospective balance of payments and domestic stability. …[E]xchange rate policies will always be the subject of the Fund’s bilateral surveillance with respect to each member, as will monetary, fiscal, and financial sector policies (both their macroeconomic aspects and macroeconomically relevant structural aspects).”
ISD para. 6: “…. Other policies will be examined in the context of surveillance only to the extent that they significantly influence present or prospective balance of payments or domestic stability.”
ISD paras. 16, 17, Guidance Note for Surveillance Under Article IV Consultations, paras. 8, 23. This follows from the principle of integration of multilateral and bilateral surveillance, ISD para. 4.
Article IV, Section 3(a).
ISD para. 23.
ISD para. 26.
According to footnote 10 of the Guidance Note for Surveillance Under Article IV Consultations, “outward spillovers are deemed significant if by themselves, or in combination with spillovers from other members’ policies, or through their regional impact, they would enter the macro-financial policy considerations of members representing a significant portion of the global economy.” There operational implications of “in combination with spillovers from other members’ policies” are not specified, however.
Prepared by Adil Mohommad, Oya Celasun and Florence Jaumotte (RES).
See Burke, Hsiang and Miguel (2015); Dell, Jones, and Olken (2014); Carleton and Hsiang (2016); and Heal and Park (2016) for literature reviews.
IMF (2017) and IMF (2020b).
These can be imperfectly captured in damage functions based only on temperatures.
Cantelmo, Melina and Papageorgiou (2019) find that disaster-prone countries grow by 1 percent less each year than non-disaster-prone countries, and that climate change may triple the growth gap.