Speech

Climate economics: from the veil of
uncertainty to three convictions for
action

Published on 25 June 2024

NGFS Annual Plenary meeting and Plenary Workshop - 25 June
2024

Speech by Francois Villeroy de Galhau, Governor of the Banque de
France

Ladies and Gentlemen, dear friends,

The NGFS is dear to my heart and it is always a great pleasure to be
among you, even virtually. I would like to warmly thank Chair Sabine
Mauderer for her invitation to speak today at the NGFS Plenary meeting.

While it began as a rather discrete initiative that eight of us took at the
time in Paris, six and a half years later the NGFS has more than 140
Members. All in all, the NGFS has published more than 35 reports on
topics such as supervision, transition plans, monetary policy, nature...
Many of which have been praised for their quality and relevance, thanks
to your work, and the global Secretariat hosted by the Banque de
France. We did not take this initiative because we were climate
advocates. We took it because we thought that, as central bankers and

supervisors, we had a duty to care about climate change in order to fulfil
our monetary and financial stability mandates.

Let me focus today on "climate economics", and on the NGFS
macroeconomic scenarios. Since their release in 2020, we have
constantly worked to improve them, "vintage after vintage".

Some studies! released or published this year suggest that the
macroeconomic consequences of climate change could amount to nearly
15% of GDP by 2050, higher than the 5% of chronic impacts (in green)
that feature in the current NGFS scenarios, which however account for
extreme events separately.

THE COSTS OF A DELAYED TRANSITION

Global GDP Impact by Climate Risk Source
NiGEM based on REMIND input

& difference from baseline / year

Net Zero 2050 Delayed Transition Current Policies

mm

14
2030 200 2050 2030 2040 2050 2050

I Gross Domestic Product (GOP) BE Geoss Domestic Product (GOP) (chronic i cence Product (GOP) (transit

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The costs of a delayed transition

This is unfortunately possible as the on-going work on the "damage
function" assessing the impact of physical risks on the macroeconomy
suggests. To remain at the forefront in this debate, the Workstream on
Scenario Design and Analysis is working on new estimates of the
impacts of physical risks for the next "vintage" of long-term scenarios, to
be published by the end of 2024.

This is the current paradox: we could see climate change becoming less
of a priority on the international and European agenda and we risk
disengagement, while the need to act is becoming more pressing. Yes,
there is a "veil of uncertainty" about its macroeconomic effects, due
partly to future political decisions regarding climate change mitigation.
For example, the initial level and change in a carbon price, or the amount

of green investment and public subsidies will be especially relevant. This
is why we are working on several scenarios, both over short and longer
term.

But being uncertain about the combined macroeconomic effects does
not mean being passive or inert. What we can already take from the
scenarios is a set of three firm convictions and prescriptions for action.

1. A shock that is global and certain
>>> an orderly transition

First, climate transition entails structural changes to the global economy
that are both universal and significant, with an overall and possibly
negative supply shock that will generate frictions and costs in terms of
the necessary reallocation of production factors. Climate change - while
its effects will likely go in the opposite direction - is comparable to
globalisation as seen several decades ago: we knew that it would have
significant effects, inevitably and everywhere, while not knowing their
magnitude ex ante. This means we should organise our transition to
make it as early, predictable and orderly as possible; this is not always
an easy task in our democracies, which tend to be short-termist, but
disorderliness would be costly.

As another consequence of this universal shock, we need to enhance
international coordination: as not all countries made the same
commitments, and face the same consequences and responsibilities,
some are tempted by free-rider or "beggar my neighbour" behaviour.
Hence climate change must be the number one priority of the "focused
multilateralism" I am calling for', be it in the G20 or in the IMF and the
World Bank.

2. Higher volatility >>> strong
commitment of Central Banks, but no
magic wand

Second, higher volatility is likely, which means shocks on both activity
and inflation. This is where we central banks have to do our job in order

to maintain a solid anchoring of long term inflation expectations despite
higher volatility. We cannot just look through it, since it is not an
unexpected and transitory shock. Delivering on our price stability
mandate and the 2% inflation target is key to avoid additional economic
volatility, and to maintain moderate long term interest rates in order to
fund the green transition.

That said, public debate should resist the « magic wand temptation » in
which central banks are seen as being able to curb climate change on
their own. I want to be crystal clear on this: monetary financing cannot
fund the transition; and central banks - and green finance - cannot be
the only green game in town; they cannot replace sound public policies
and corporate transition plans.

Appropriate incentives are needed. The difference between Europe and
the United States is particularly sensitive when it comes to the form
these incentives should take: regulation (as in the case of Europe's highly
ambitious "green deal"), subsidies (as with the US Inflation Reduction
Act), or carbon pricing?

THE TRIANGLE OF INCENTIVES TO SHARE THE TRANSITION EFFORT

REGULATION

(punitive ecology?)

ff pO.

GOVERNMENT SUBSIDIES CARBON PRICING

(fiscal overshoots?) (social resistance?)

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The triangle of incentives to share the transition effort

The three corners of this are not necessarily incompatible; each has its
limits, taken in isolation: fear of "punitive ecology" in the case of
regulation; fiscal overshoots and political hazards for subsidies; and
strong social resistance in particular to carbon pricing. So we need a
combination of these three solutions.

The fact remains that the price of carbon will have to rise: although
politically unpopular, it remains an economic no-brainer. Whatever form it
takes, carbon pricing will have to be global - not just national or
European - and socially equitable - with a fair redistribution of part of its
receipts. Europe - which is relatively ahead in this field - needs to press
relentlessly for this international "new frontier". " Only a price signal will
succeed in aligning the behaviour of firms, consumers and private
finance, by making returns on green investments attractive.

On a fairer pricing of climate risk on financial markets, central bank
operations and their greening have a role to play by the way, giving the
right market signals and inducing changes. With Christine Lagarde, we at
the ECB are pioneers in implementing a greening of our monetary
operations, which should include our collateral framework.

3. Funding green investments >>>
solvable through smarter finance

The amounts required to fund the transition are considerable: according
to different estimates, the additional annual investment needs to meet
our climate objectives in 2030 range from 2.6% of GDP to 3.7% of GDP in
Europe. At the global level, investments in the energy sector alone will
have to rise up to more than 2% of GDP in 2030, doubling from 2020
levels. ¥!

EUROPEAN INVESTMENT NEEDS, AND PRIVATE RESOURCES

Net additional annual investment European Union's net lending
needs up to 2030 (% of GDP) (% of GDP)

10

& & 6 Fw © NR ke Oo &

2011 2014 2017 2020 2023

Borepens Comeesion MCE (2024) 'm= Public financial dissaving 'mm Private financial saving -total

g sectors

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European investment needs, and private resources

But the question of how to finance investments is solvable, subject to
one important prerequisite: the private sector has a part to play in the
effort. And it will play it more easily if climate and transition policies
contribute to making these investments profitable. There is no shortage
of resources. For example, Europe possesses an "unknown resource" of
private savings surplus:"" after deducting public deficits, the EU's net
external lending amounts to 1.8% of GDP, close to EUR 300 billion. It is
therefore crucial to mobilise these resources.

Sustainable finance clearly offers a "highway" in this regard. In Europe,
the introduction a comprehensive body of regulations (CSRD,
supervisory expectations, green taxonomy, SFDR, etc.)¥! is providing a
framework to foster the development of green finance. The EU is indeed
a leading issuer of green bonds, accounting for 40% of the global market
in 2023.

DEVELOPING SUSTAINABLE FINANCING INSTRUMENTS

Green bond issuance in 2023
(billion €)

220 BY

r $ FS
aro EF SF ES
yw og ee * eS P
Fo x e
ve * Aa

NGFS PLENARY MEETING + JUNE 2024

Developing sustainable financing instruments

Green securitisation is another promising lever as I have previously
advocated," with the potential to boost bank's capacity to finance green
projects by several hundred billion euro a year in Europe.

What is true in Europe also holds elsewhere: the development of green
finance, a focus on making sure that financial institutions are properly
assessing and managing climate risks and planning for the transition has

the potential to accelerate the local, regional and, eventually, global
transition to net zero.

Therefore, provided we have the right economic incentives, the climate
transition can be financed. These concrete focuses for action will enable
us to overcome our natural tendency to stop listening when faced with
pessimistic announcements. It was memorably depicted by Homer with
Cassandra: she repeatedly tried to warn that Troy would fall should they
let Ulysses' Trojan horse get into the city. Let us heed the warnings of
the scientific community, and do our part, both individually and
collectively, to successfully achieve the climate transition. This is the
time and place to listen to Gramsci's famous call for "the pessimism of
intelligence and the optimism of the will". I thank you for your attention.

Bilal (A.) and Kanzig (D.), The Macroeconomic Impact of Climate Change:
Global vs. Local Temperature, NBER Working Paper, May 2024 ; Kotz (M.),
Leermann (A.) and Wenz (L.), The economic commitment of climate
change, Nature, 17 April 2024

Villeroy de Galhau, F., How central banks should face instability and
fragmentation, speech, 12 April 2023

iliFrance and Europe: from crisis management to a longer-term ambition,
Letter to the President of the Republic, 22 April 2024.

'\See in particular the working paper by V. Gaspar (IMF) and R. de Mooij
(IMF), "How does decarbonization change the fiscal equation?" Peterson
Institute, November 2023.

'Villeroy de Galhau, Financing the climate transition: building bridges

between needs and resources, speech, 22 April 2024.

VINGFS, scenarios for central banks and supervisors, Workstream on
Scenario Design and Analysis, November 2023.

"llFinancial savings based on national accounts: savings after investment
and capital transfers.

viliSustainable Finance Disclosure Regulation (SFDR) and Corporate
Sustainability Reporting Directive (CSRD).

Villeroy de Galhau, From a Capital Markets Union to a genuine Financing
Union for Transition, speech, 23 February 2024.

Updated on 25 June 2024