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| Carbon Pricing, Dual Financial Friction and Dual Pillar Regulation |
| WANG Bo, XU Piaoyang
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| School of Finance, Nankai University |
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Abstract At the Boao Forum for Asia 2021 Annual Conference, Yi Gang stated that “we should accelerate research on the introduction of climate change factors in stress tests of financial institutions and incorporate climate factors into the investment risk management framework. At the same time, we will step up support for carbon emission reduction by leveraging commercial bank ratings, deposit insurance rates, and a macro-prudential assessment framework. … the central bank will focus on macro-prudential policies to deal with the potential systemic risks brought by climate change with monetary policies to support green development … and further strengthening the coordination between macro-prudential policies and monetary policies will be the key work in the process of achieving the 30/60 carbon target.” Therefore, research on the economic impact of carbon trading and carbon tax policies is of great significance. Additionally, the impact of climate policy and the roles of financial friction and the dual-pillar policy in the economic transformation process must be thoroughly discussed. Realizing China's 30/60 goals, constructing and perfecting the two-pillar framework to deal with climate transition risks, maintaining financial stability and achieving a smooth economic transformation and upgrade are of great theoretical and practical value.
This study makes three main contributions to the literature. First, it evaluates the macroeconomic effects of carbon pricing from both short-and long-term perspectives. It also explores the exogenous macroeconomic shocks of carbon price fluctuations within upper and lower limits. Second, we effectively distinguish between the financial accelerator effects of asset price volatility and risk aversion. Third, we combine the two-pillar and climate policies to evaluate the effectiveness of the two-pillar policy using certainty simulation and welfare analysis. This approach is an effective way to improve the two-pillar framework approach to dealing with the risks of economic transformation.
Dynamic stochastic general equilibrium modeling shows that, first, two kinds of carbon pricing can contribute to high-quality long-term economic development in China, despite some short-term negative effects. Floating carbon prices intensify economic fluctuations, but a lower limit on the market price helps alleviate these fluctuations. Second, financial friction magnifies the negative economic impact of climate policies. Under dual financial friction, the financial accelerator effect caused by the financial sector avoiding default risk is as important as the financial accelerator effect caused by the financial friction between the financial sector and residents. Third, in response to the economic effects of climate policy, monetary authorities should not overly focus on short-term inflation; rather, they should focus on output and demand. With a structural imbalance of supply and demand, expanding green investment, promoting green production and guiding consumer demand are the best ways to resolve inflation. Moreover, under the two-pillar regulation, macroprudential policies can effectively mitigate the negative economic impact of climate policies, enhance financial stability and improve residents' welfare.
The following policy recommendations are offered: First, combining fixed and floating carbon pricing will help achieve the 30/60 carbon target. A fixed carbon price can effectively cope with carbon technology changes, reducing their economic impact. Second, risk aversion in the financial sector will significantly exacerbate the negative impact of climate policies. Therefore, the government should encourage the financial sector to share in the risks and provide financial services to the real economy. However, attention should be paid to risk concentration in the financial sector. Third, macro-prudential policy should be used to address the financial instability and economic fluctuations that result from climate policy. Monetary policy should address structural supply-demand imbalances. For short-term structural supply-demand imbalances that lead to inflation, monetary authorities should promote production, expand green investment, promote supply-demand balance and address inflation at the root.
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Received: 28 June 2021
Published: 01 January 2022
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