# 2. Context and background

Despite their significant fiscal and macroeconomic implications, work programs around climate change mitigation and adaptation are poorly integrated into the decision-making process of Pakistan’s Ministries of Finance and Planning. In particular, the impacts of climate change are not measured by the macro-fiscal tools used by policy makers in Pakistan. Neither the State Bank of Pakistan (SBP), nor the Ministry of Finance currently uses macroeconomic forecasting and analysis models that capture the potential impact of climate change on the country’s economy or of the economy on climate. In large part this reflects the underlying complexity and specialized nature of many climate models, that tend to be housed in Environment Ministries or are run by outside consultants at the request of a Ministry.<sup>3</sup> As a result, policy makers lack the tools necessary to quantify the effect of climate policies (or inaction) on economic growth, fiscal sustainability and Pakistan’s broader development agenda.

The work described in this paper addresses this gap by integrating a climate change module into an existing macro-fiscal framework with an easy-to-use interface. The objective is to provide policy makers in Ministries of Finance and Planning with economic models that can be used to plan and analyze the range of economic issues that currently preoccupy them, including fiscal policy (spending and revenues), monetary policy, sectoral activity, external accounts, but which also generate climate outcomes (emissions, economic damages from heat, changed rainfall patterns and pollution) that current tools do not. The model developed maps out the linkages between macroeconomic policy levers, fiscal aggregates and climate outcomes and incorporates a comprehensive set of policy levers covering mitigation measures, co-benefits derived from mitigation, damages caused by climate change and potential adaptation policies.

The work described in this paper focuses on extending an existing macroeconomic modeling framework, which is derived from the World Bank’s Macro-fiscal model (MFMod). MFMod is a macrostructural model (see Burns _et al._ (2019) for a technical description) similar to many models used at central banks and ministries of finance around the world. It is the main model used by the World Bank to produce its biannual Macro Poverty Outlook publication.

The model extensions of MFMod for Pakistan (PAKMod) draw from the existing climate literature to introduce emissions and pollution modules; damage functions from higher temperatures, pollution and flooding on economic activity; and an adaptation module to analyze the economic benefits of adaptation investments to adjust to climate change. Importantly, PAKMod recognizes the pervasive informality in the Pakistan economy. Combined with the pre-existing features of the MFMod framework, PAKMod provides a vehicle for systematically evaluating side-by side the climate impacts, as well as the traditional social and economic impacts (growth, fiscal sustainability, inflation and current account stability) of both climate and non-climate policies. While Pakistan is used as a pilot case, many of these climate features can be added to other country models too.

It is expected that the economic modeling techniques developed in this activity will serve as a blueprint for future applications to other countries.

> 3 That current modeling has room for improvement is expressed by Ghafoor _et al._ (2016): “[C]limate-economic models need to be extended to include a wider range of social and economic impacts. Gaps need to be filled, such as the economic responses of developing countries”.

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