As Prepared for Delivery
1. Introduction
Thank you so much for the kind welcome. I’m so glad to be here talking about this important topic.
In this room today, I am fortunate to be joined by so many with expertise in climate economics and related issues; many of you have been studying these issues for years or decades. For me, much of my education on climate-related matters began in earnest as the senior economic adviser to the Biden campaign, where climate was a central focus across the policy platform. Astute followers of the campaign remember that the first set of policy proposals released were devoted to reversing the harmful impacts of climate change, including, for example, a commitment to reaching ambitious emissions targets.
As the remainder of the policy platform was developed, it was clear that the Biden vision was not to regard climate policy as an isolated set of reforms, but rather to incorporate climate across the entire platform. Our housing policies included funding for resiliency and energy efficiency. The manufacturing agenda included plans to boost production of electric cars. Our workforce training plans included programs to train workers to address climate change. Our racial equity proposals were designed to mitigate the unequal impacts of climate change. And our infrastructure and climate agendas were so interlinked that it was at times difficult to separate the two.
My education in climate policy has continued in the Treasury Department, where Secretary Yellen has made climate a key focus. She created new positions within the Department devoted to climate, including the first-ever counselor for climate policy and a new Deputy Assistant Secretary for Climate and Energy Economics. From legislative proposals to domestic grants programs to interactions with the multilateral development banks, climate policy has consumed much of the attention of this Treasury Department as we work tirelessly to meet the commitments President Biden laid out in 2020 and in proposals ever since.
Today, I will speak about three issues: macroeconomic risks from climate change, managing the transition to a clean economy, and the dominant role financial institutions will play in this transition.
2. Climate and Macroeconomics
The macroeconomic impact of climate change is an important area of research within the academic economics community, but also an area of increased focus for governments, central banks, and private forecasters. Some of the leading models are top-down—like the Nordhaus DICE model—which are based on a neoclassical growth model subject to calibrated damage and abatement costs.1 An alternative method uses a bottom-up approach to empirically estimate damages from climate change in terms of reductions to the level of U.S. or global GDP, such as the work by Dell, Jones, and Olken2 and Burke, Hsiang, and Miguel.3
The Biden Administration is working to incorporate this modeling into our macroeconomic and budget projections. As part of an executive order issued last year,4 the Office of Management and Budget and Council of Economic Advisors are leading an effort to incorporate climate change impacts into the economic and budget projections in the annual Troika budgeting process. Treasury, as a central contributor to the budgeting process, is working to tackle both conceptual and quantitative questions about the impact of climate change on the macroeconomy and the federal government’s fiscal position.
As we survey the literature and construct our own forecasts, climate change raises important conceptual issues in addition to difficult questions of the size of impacts. One way to conceptualize the impacts of climate change is simply as a level shift in activity. Indeed, both the top-down and bottom-up estimates of macroeconomic damages are typically formulated in terms of level effects on either productivity or economic output. While we can debate the specific impacts, this approach feels largely uncontroversial, with the only question being the magnitude and composition of the devastation owing to a changing climate.
There are other conceptual approaches to the impacts of climate change, such as regarding climate change as a tax on production, which is, of course, distortionary and will move our economy away from optimal levels of production. For example, think of the additional costs of storm-proofing residential homes or air conditioning office buildings. In other cases, climate change may functionally act as a tax on investment by reducing the return to previously made investments, such as ownership of waterfront property in areas vulnerable to rising sea levels.
I believe that an important and underappreciated framing for the economic impact of climate change, however, is as an increase in volatility or, put differently, as an increased probability of rare disasters. As I will discuss, our experience with climate change in recent years is suggestive that economic impacts of climate change may best be regarded as increased probability of disaster shocks.
This perspective raises the methodological question of the primary channels through which climate change impacts economic production. Through the lens of an aggregate production function, there are potentially mechanisms through which climate change reduces the labor force, capital stock, and total factor productivity. As a disaster shock, impacts on the capital stock also appear particularly important and relevant for macroeconomic dynamics. Climate change could damage or destroy significant public and private physical infrastructure and render existing capital obsolete or less productive. Like a war or natural disaster, repeated shocks to the capital stock may paradoxically increase average GDP growth rates, but, nevertheless, leave welfare lower as average consumption falls and becomes more volatile.
The leading edge of climate change impacts appears to fit the description of disaster shocks with disproportionate impacts on the capital stock. The National Oceanic and Atmospheric Administration reports that 2021 saw 20 distinct billion-dollar disasters with a total cost of $152 billion, trailing only 2017 and 2005.5 Billion-dollar disaster events are up roughly ten-fold since 1980 after accounting for inflation. While damages relative to GDP and the capital stock are still small, increases of a similar magnitude over the next 20 to 30 years would become increasingly first-order relative to output or the capital stock.
Setting aside natural disasters, there is a case to be made that climate change has led to production shortfalls and elevated prices for food, energy, and other commodities. The worst drought on record in Brazil last year has contributed directly to rising prices for soybeans, meat, and coffee and a reduction in hydropower—the primary source of power generation for the country.6 Drought conditions in Brazil appear likely to persist into 2022, further stressing global food commodities already facing severe disruption from the fallout of the Russia-Ukraine war and high fertilizer prices.7
The ripple effects of the hydropower shortfall extend to U.S. energy markets: the United States is exporting diesel for power generation to Latin America, amplifying the impact of supply disruptions from Russia’s brutal war in Ukraine and sending U.S. diesel prices higher.8 As an input to trucking and agricultural production, higher diesel prices are likely to flow through to prices of food and manufactured goods—and thus to headline and core inflation.
The United States itself has faced unprecedented drought conditions across the West that are likely contributing to food inflation. Staple grain prices increased through 2021 from the combined impacts of drought in the United States and Brazil. Western cattle ranchers had difficulty feeding their livestock, constricting supply as demand surged back.9 Record heat in the summer of 2021 caused forest fires in Canada, culminating in fall rains washing-out highways and railroad tracks. The upshot was further increases in timber prices—a market already stressed by booming residential investment.10
The cases I highlight here are examples of supply shocks—temporary, sharp reductions in capacity or increases in raw material prices that both reduce output and raise prices. In my view, climate change is likely to result in an increase in the frequency and severity of supply shocks. This is not dissimilar to the challenges posed by the Covid pandemic, though likely to unfold more incrementally than the supply shocks we’ve experienced over the past two years—including disrupted labor supply and production in both the United States and overseas from Covid outbreaks in meatpacking plants in the summer of 2020 to shutdowns of factories in Southeast Asia during the Delta wave to widespread quarantines and absences in the United States during the Omicron wave.
While the economics literature has largely focused on the impacts of rising temperatures, we are also all currently experiencing a supply shock related to our dependence on fossil fuels. We at Treasury, together with our colleagues across the U.S. government, are keenly aware of the economic costs associated with the high energy prices that have followed Russia’s invasion of Ukraine. The loss of life and acute suffering in Ukraine is devastating, but Russia’s aggression has also inflicted more hidden economic tolls that ripple across the world and are felt most acutely by low-income countries. The lesson, one we’ve learned across our country’s history, is that continued dependence on fossil fuels leaves us exposed to geopolitical disruptions. This is why President Biden, in an address on energy security delivered earlier this year, declared that “[W]e and the whole world need to reduce our dependence on fossil fuels altogether. We need to choose long-term security over energy and climate vulnerability.”11
In addition to geopolitical stability, it is imperative to consider the potential impact of persistent supply shocks on macroeconomic stability. As many in this audience could attest, supply shocks pose particular challenges for monetary policy. Interest rate policy, quantitative easing, and credit policy are powerful tools for addressing demand shocks; the initial response to the Covid pandemic illustrated the efficacy of these tools. By contrast, supply shocks are not amenable to changes in interest rates or financial conditions; negative supply shocks confront monetary policy with an unfavorable inflation/output tradeoff. More subtly, supply shocks from climate change may also be harder to diagnose; decomposing the relative contribution of climate impacts to output and inflation is likely a challenging task.
Supply shocks pose similar challenges for fiscal policy. During the pandemic, a robust fiscal response kept most household income intact despite the disruptions to in-person activity. The United States fully recovered its pre-pandemic level of GDP in 2021 and is now close to recovering its pre-pandemic trend level of GDP. However, fiscal policy could not quickly alleviate the shortages of high-quality masks and personal protection equipment at the start of pandemic. Fiscal policy has limited control, particularly in the short-term, to redress supply-chain issues and bottlenecks that have emerged as a result of the substitution to goods away from services. Today 1.5 million housing units are under construction but not completed due to supply chain issues—nearly a 50-year high.12 Getting that housing to completion would likely have meaningful impacts on shelter inflation, but this is an example of where both fiscal and monetary policy have limited impact.
Climate change is likely to pose challenges that are similar in nature for fiscal policy. As the Office of Management and Budget has detailed, federal property and public capital are at risk from climate-related natural disasters such as flooding and wildfires.13 As the insurer of last result, the federal budget will likely bear part, or most, of the burden of losses from natural disasters—losses that are rising quickly in magnitude. Climate-related disruptions to energy or agricultural production are not amenable to short-term fixes. Instead, fiscal policy to address climate change will need to be forward-looking—focused on resilience and mitigation through building inventories, strengthening infrastructure, and reshoring and reinforcing supply chains.
3. Managing the Transition
With these types of macro risks at hand—and thinking long term about the impacts of climate change on generations to come—the Biden Administration is firmly committed to using all its power to reduce greenhouse gas emissions. Recall that on his first day in office, President Biden fulfilled his promise to rejoin the Paris Agreement,14 signaling that America is back in the fight to tackle climate change. In April 2021, the President announced an ambitious nationally determined contribution, which is our goal as part of the Paris Climate Agreement: this is a 50 to 52 percent reduction in U.S. greenhouse gas emissions relative to 2005 levels by 2030.15
I will outline some specific examples of the Administrations’ climate activities, focusing on three broad areas: (1) initiatives in the Infrastructure Investment and Jobs Act, or the Bipartisan Infrastructure package; (2) reforms included in the Build Back Better agenda; and (3) other policy initiatives.
A. Infrastructure Investment and Jobs Act
The first, the Infrastructure Investment and Jobs Act, signed into law in November, included several provisions designed to jumpstart the transition to a clean energy economy,16 such as:
- $7.5 billion in funding to invest in a nationwide network of electric vehicle charging stations to fulfill the President’s pledge to install 500,000 chargers;
- Establishing a new process to site transmission lines to carry the wind and solar electricity to customers, along with $16.5 billion in funding for electric grid upgrades; and
- Securing substantial investments in research and development, including pilot projects for things like clean hydrogen and carbon capture and sequestration.
B. Build Back Better
The second, the Build Back Better agenda, can completely transform our clean energy future, setting the United States—and the world—on a path of steady and deep decarbonization. I do not have any update for you on the legislative prospects but will highlight some of what was included in the version that passed the House last year.17
In general, the legislation would yield over $500 billion in spending for climate, with more than $350 billion of these benefits delivered through the tax code.
At a high level, the plan is to incentivize the sizable investments needed to transform the electricity sector—where we anticipate much of the early emission reductions—and then begin to electrify other energy uses, for example, through electric vehicles or by using electricity to make hydrogen to use in industrial processes. So, in the case of the large emitting sectors other than power—industry, transport, and buildings—we are paving the way to achieving greater reductions later, planting the seeds for electrification with the understanding that those seeds may take some time to germinate.
It is important to highlight the central role of tax credits, which serve multiple roles: both to encourage the deployment of existing technologies (including renewables like wind and solar) and incentivizing new or emerging technologies (such as carbon capture and sequestration).
Some of the specifics include:
- An expansion of existing Production Tax Credits and Investment Tax Credits for renewable electricity generators. We project that these will primarily be used for wind and solar in the near future, but the tax credits are not specific to wind and solar, and we have notably expanded these tax credits to include energy storage.
- A new Investment Tax Credit for high-voltage transmission, to carry the new wind and solar—incentivized by the tax credits I just mentioned—to the consumers.
- Electric vehicle tax credits up to almost $13,000 depending on where the vehicle is manufactured and the use of union labor.
- In terms of new technologies, we extend and enhance tax credits for carbon capture and sequestration and have introduced a new credit for direct air capture and another one for clean hydrogen.
From an economic perspective, the plan is to use tax incentives to subsidize the good—that is, clean energy—and to address market failures. Let me highlight two specific examples of market failures.
One, with chargers for electric vehicles, we know that to the extent my charger makes you feel more comfortable owning an electric vehicle, whether or not you charge at my station, my incentive to invest in that charger is too low. So, there is a clear role for government to invest in things like a nationwide network of electric vehicle chargers to jumpstart electric vehicle adoption.
Another major market failure addressed by the President’s plan is the under-provision of research and development. Fortunately, the Infrastructure Investment and Jobs Act helps correct for this failure by devoting significant funding to investments in early-stage technologies.
C. Beyond Legislation
Beyond legislation, the Administration is leveraging administrative and regulatory tools in the climate agenda. Regulation has played—and will continue to play—a crucial role. For example, the Environmental Protection Agency (EPA) has already proposed stronger rules on cross-state air pollution, which help recognize the environmental costs of generating electricity with fossil fuels.18 The EPA is also preparing draft rules on greenhouse gas emissions from the power sector. As another example, the National Highway Traffic Safety Administration announced this year improved fuel-economy standards that will result in a fleetwide average for new cars and trucks of 49 miles per gallon by 2029 and help support the Administration’s goal of having electric vehicles account for 50 percent of new vehicles sales by 2030.19
The Administration also recognizes the power of federal procurement to help spur the decarbonization process. In particular, the federal government has a portfolio of 300,000 buildings, a fleet of 600,000 cars and trucks, and annual purchasing power of $650 billion in goods and services. In December, the President signed an executive order that directs the federal government to use its scale and procurement power to achieve several ambitious goals.20 For instance, the federal government will work with utilities, developers, technology firms, investors, and others to purchase electricity produced from resources that are 100 percent carbon free for all its operations by 2030. Similarly, 100 percent of the vehicles the federal government purchases will be zero-emission vehicles by 2035, including 100 percent zero-emission light-duty vehicle acquisitions by 2027. The executive order led to a Buy Clean Task Force to procure low-carbon construction materials.
Just think about this—if you’re an entrepreneur with a new way to make low-carbon steel or cement, you can look to the federal government, whose purchases are more than 3 percent of GDP, as a known customer for your product.
4. Climate Change and the Financial Sector
You may have figured out that I have described a lot of investments in clean energy that will be encouraged by federal procurement standards, potentially eligible for federal tax credits but still, fundamentally, financed by the private sector. Put differently, to rapidly decarbonize our economy at the pace recommended by scientists, the private sector will need to invest trillions of dollars. The International Energy Agency estimates that to reach net zero emissions by 2050, annual clean energy investment worldwide will need to more than triple by 2030 to around $4 trillion—that’s one-fifth of U.S. GDP invested every year.21 Of all the agencies in the federal government, Treasury is the most concerned with activities in the financial sector, so this is something we are following keenly. Do investors have the information they need to direct their funds, should they be so inclined, to the most promising clean, climate-aligned investments? And, on the flip side, do investors have the information they need to properly account for the costs and risks associated with projects or sectors that may be particularly impacted by climate change?
In general, we are seeing a tremendous increase in investors’ interest in assessing climate-related risks and opportunities and appetite for the types of information I’ve just described. Since taking office, Secretary Yellen has repeatedly emphasized the importance of consistent, comparable, decision-useful climate-related disclosures. Disclosures were a major theme of the Financial Stability Oversight Council’s October 2021 report on climate-related financial risk,22 which identified climate change as an emerging threat to U.S. financial stability and set forth over 30 recommendations for financial regulators to respond. At the end of March, the Securities and Exchange Commission (SEC) took a major step forward with proposed rules that would enhance and standardize the climate related disclosures of public companies.23 The SEC’s proposal is an important step to provide investors with the information they are seeking and strengthen the overall resilience of the financial system.
While independent financial regulators are taking steps within their mandates and authorities, in many ways, the private sector is leading the way—recognizing the inevitability of addressing climate change and monitoring climate-related risks. For example, firms responsible for approximately $130 trillion in global financial assets have committed to net zero emissions by midcentury under the Glasgow Financial Alliance for Net Zero.24 These firms have also committed to relying on science-based guidelines in their target setting and to adopting interim targets for 2030.
One consequence of this explosion of net zero commitments is a surge in interest in voluntary carbon markets. At Treasury, we are watching the developments in this space, especially given the likely growth in the demand for voluntary offsets. The “net” in net-zero commitments recognizes that not all sectors will be able to drive emissions to zero, so we need to think about removing carbon (for example, by planting forests or scaling up direct air capture technology) to offset those last few, highly valuable, and hard to reduce emissions.
We recognize the significant potential that would come from having robust, high-integrity markets that can channel private capital to offset projects and uses that are clearly additional (that is, would not happen without the private capital) and generate permanent emissions mitigation. Personally, I suspect that one of the most impactful uses of offsets would be to support innovative new carbon removal technologies like direct air capture. But we enter this space with our eyes open and recognize the challenges in ensuring voluntary carbon markets realize that potential.
5. Conclusion
Putting all of this together, what is the vision for the U.S. economy, the clean energy sector, and public investment over the next 15 years? I would highlight three outcomes in particular: a more efficient allocation of private capital, optimal levels of public investment, and international coordination.
On the first, private capital will be the engine that drives us all towards a cleaner economy and helps us avoid the macroeconomic impacts I discussed. It really plays a crucial role, so I believe that one of the most important roles of the government should be ensuring that private investors have all the information they need to make these important decisions carefully and constructively.
While private capital is crucial, it must be complemented by public investment. I have highlighted several examples of market failures and public good provision targeted by our current proposals. We will need to continue to identify opportunities to make these types of public investments so that the private capital is starting from a solid foundation.
Finally, as we all know, climate change is a global problem, and the United States currently accounts for less than 13 percent of global emissions. So, all of our efforts need to recognize the potential for spillovers to the rest of the world.
I’d like to conclude by recalling a quote last year by Secretary Yellen, who noted that “Climate change isn’t just a specter on the horizon, a problem for future generations. It is a present challenge, and we must adapt.”25 I agree, which is why it’s so important to have conferences like this one so that we can expand our expertise, gather new information, and adapt smartly.
Thank you so much.
#
[1] Nordhaus, William D., “Evolution of Modeling the Economics of Global Warming: Changes in the DICE Model, 1992-2017,” Climate Change, Vol. 148, 623–640.
[2] Dell, Melissa, Benjamin F. Jones, and Benjamin A. Olken, 2012. “Temperature Shocks and Economic Growth: Evidence from the Last Half Century,” American Economic Journal: Macroeconomics, Vol. 4(3), 66–95.
[3] Burke, Marshall, Solomon M. Hsiang, and Edward Miguel, 2015. “Global Non-Linear Effect of Temperature on Economic Production,” Nature, Vol. 527, 235–239.
[4] Executive Office of the President, May 2021. “Executive Order on Climate-Related Financial Risk,” https://www.whitehouse.gov/briefing-room/presidential-actions/2021/05/20/executive-order-on-climate-related-financial-risk/
[5] NOAA National Centers for Environmental Information (NCEI) U.S. Billion-Dollar Weather and Climate Disasters (2022).https://www.ncei.noaa.gov/access/billions/, DOI10.25921/stkw-7w73. Comparison based on five-year average of disaster costs from 1985 to 2021.
[6] NASA, Earth Observatory, June 2021. “Brazil Battered by Drought,” https://earthobservatory.nasa.gov/images/148468/brazil-battered-by-drought
[7] The Wall Street Journal, April 2022. “Corn and Soybeans Near Record Prices, Push Food Costs Higher,” https://www.wsj.com/articles/corn-and-soybeans-near-record-prices-push-food-costs-higher-11651092056
[8] Reuters, April 2022. “Cost of U.S. diesel exports to Latin America rise on shortage,” https://www.reuters.com/business/energy/cost-us-diesel-exports-latin-america-rise-shortage-2022-04-05/
[9] The Wall Street Journal, July 2021. “Drought’s Toll on U.S. Agriculture Points to Even-Higher Food Prices,” https://www.wsj.com/articles/droughts-toll-on-u-s-agriculture-points-to-even-higher-food-prices-11625137201
[10] The Atlantic, January 2022. “Lumber Prices Are off the Rails Again. Blame Climate Change,” https://www.theatlantic.com/science/archive/2022/01/why-climate-change-pushing-lumber-prices/621288/
[11] Executive Office of the President, March 2022. “Remarks by President Biden on Actions to Lower Gas Prices at the Pump for American Families,” https://www.whitehouse.gov/briefing-room/speeches-remarks/2022/03/31/remarks-by-president-biden-on-actions-to-lower-gas-prices-at-the-pump-for-american-families/
[12] United States Census Bureau, June 2022. “Monthly New Residential Construction, May 2022,” https://www.census.gov/construction/nrc/pdf/newresconst.pdf
[13] Executive Office of the President, April 2022. “Climate Risk Exposure: An Assessment of the Federal Government’s Financial Risks to Climate Change,” https://www.whitehouse.gov/wp-content/uploads/2022/04/OMB_Climate_Risk_Exposure_2022.pdf
[14] Executive Office of the President, January 2021. “Paris Climate Agreement,” https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/20/paris-climate-agreement/
[15] Executive Office of the President, April 2021. “FACT SHEET: President Biden Sets 2030 Greenhouse Gas Pollution Reduction Target Aimed at Creating Good-Paying Union Jobs and Securing U.S. Leadership on Clean Energy Technologies,” https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/22/fact-sheet-president-biden-sets-2030-greenhouse-gas-pollution-reduction-target-aimed-at-creating-good-paying-union-jobs-and-securing-u-s-leadership-on-clean-energy-technologies/
[16]Executive Office of the President, November 2021. “Fact Sheet: The Bipartisan Infrastructure Deal,” https://www.whitehouse.gov/briefing-room/statements-releases/2021/11/06/fact-sheet-the-bipartisan-infrastructure-deal/
[17] Congress.Gov, November 2021. “H.R. 5376 - Build Back Better,” https://www.congress.gov/bill/117th-congress/house-bill/5376
[18] United States Environmental Protection Agency, June 2022. “Cross-State Air Pollution Rule (CSAPR),” https://www.epa.gov/csapr
[19] United States Department of Transportation, NHTSA, April 2022. “USDOT Announces New Vehicle Fuel Economy Standards for Model Year 2024-2026,” https://www.nhtsa.gov/press-releases/usdot-announces-new-vehicle-fuel-economy-standards-model-year-2024-2026
[20] Executive Office of the President, December 2021. “Executive Order on Catalyzing Clean Energy Industries and Jobs Through Federal Sustainability,” https://www.whitehouse.gov/briefing-room/presidential-actions/2021/12/08/executive-order-on-catalyzing-clean-energy-industries-and-jobs-through-federal-sustainability/
[21] International Energy Agency, May 2021. “Net Zero by 2050: A Roadmap for the Global Energy Sector,” https://www.iea.org/reports/net-zero-by-2050
[22] U.S. Department of the Treasury, October 2021. “Financial Stability Oversight Council Identifies Climate Change as an Emerging and Increasing Threat to Financial Stability,” https://home.treasury.gov/news/press-releases/jy0426
[23] U.S. Securities and Exchange Commission, March 2022. “SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors,” https://www.sec.gov/news/press-release/2022-46
[24] Glasgow Financial Alliance for Net Zero, 2022. “About Us,” https://www.gfanzero.com/about/
[25] U.S. Department of the Treasury, October 2021. “Treasury Releases Climate Action Plan,” https://home.treasury.gov/news/press-releases/jy0392