Financing the low-carbon transition: The impact of financial frictions on clean investment

56 Pages Posted: 9 Feb 2022

See all articles by Hendrik Schuldt

Hendrik Schuldt

Potsdam Institute for Climate Impact Research

Kai Lessmann

Potsdam Institute of Climate Impact Research

Date Written: December 16, 2021

Abstract

Climate policies such as carbon prices aim to increase the risk-adjusted returns of capital investment in green technologies vis-à-vis conventional fossil investment. The purpose of the financial sector is to channel capital flows from investors to projects offering the highest risk-adjusted returns. An efficient climate policy outcome thus relies on efficient financial markets. In reality, financial frictions such as bankruptcy costs and uncertainty about entrepreneurial success influence financial intermediation and can distort the transmission of climate policy. This study analyses the impact of emission taxes on mitigation and low-carbon investment in the presence of financial frictions. We employ a two sector (clean and dirty) environmental dynamic stochastic general equilibrium (E-DSGE) model with financial frictions. The model is calibrated to the Euro Area in 2017 and features differentiated financial characteristics among the sectors. We simulate the transition of the economy in line with the 2030 Climate Target Plan. We find that financial frictions decelerate the response of the economy to the carbon tax and the mitigation target will be missed by 11 percentage points. Moreover, the adverse effects of financial frictions increase if climate policy is delayed. We further identify a volume and a risk effect that drive the impact of a financial wealth shock and an uncertainty shockon emission intensity.

Keywords: climate policy, financial frictions, DSGE, low-carbon, transition

JEL Classification: Q58, E32, G32

Suggested Citation

Schuldt, Hendrik and Lessmann, Kai, Financing the low-carbon transition: The impact of financial frictions on clean investment (December 16, 2021). Available at SSRN: https://ssrn.com/abstract=4029841 or http://dx.doi.org/10.2139/ssrn.4029841

Hendrik Schuldt (Contact Author)

Potsdam Institute for Climate Impact Research ( email )

Kai Lessmann

Potsdam Institute of Climate Impact Research ( email )

HOME PAGE: http://https://pik-potsdam.de/members/lessmann

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