The design of macroeconomic scenarios for climate change stress tests

Abstract

The challenges of climate change affect all aspects of the economy, including financial stability, which may be affected both by the physical risks (associated with the climate change process itself) and the transition risks (associated with initiatives to curb the climate change process). This article presents a model designed to produce macroeconomic scenarios, chiefly related to transition risks, to serve as a basis for stress tests to verify that all the components of the financial system are prepared for possible adverse events of this type. In particular, these scenarios are based on a hypothetical rise in the price of CO2 emission allowances, over a 2-5 year horizon. The model simulates the impact of this shock on the Spanish economy, paying particular attention to sectoral asymmetries arising from the intensity with which different types of energy are used in each industry, the interdependencies summarised in the input-output tables for the Spanish economy and the general equilibrium effects in terms of relative price changes and sectoral reallocation.