Green credit guidance

Green Credit Guidance A formal framework of the link

between Finance, Growth and the Environment

Giovanni BernardoGiorgos Galanis

New Economics FoundationLondon

Outline

1. Why we need a new economic modeling framework

2. Our approach3. The basic model4. How to include environmental variables5. Simulations.6. Contribution to the relevant literature.

Giovanni Bernardo – Giorgos Galanis - New Economics Foundation

nef macro modeling

• nef has been developing a model which links growth, finance and environment.

• We use a methodology called system dynamics to build theories concerning the dynamic functioning of the system and run numerical simulations of possible macro scenarios.

• This is an ongoing research project, but we feel the modeling tools we have developed are already able to show some original results and contribute to the current economic debate.

• In a previous presentation we have presented the way we model the banking system (LINK), employing it to analyze the debate between Krugman and Keen regarding debt and aggregate demand (LINK) .

• In this presentation, we deal instead with the way we include environmental variables in the core model.

http://www.neweconomics.org/blog/entry/our-new-economic-model-why-banks-matter

http://www.neweconomics.org/blog/2012/07/25/reconciling-krugman-and-keen-using-nefs-model

A new modeling framework

• Understand the links between finance, output, income distribution and environment.

• Study the effects of different policies on the above.

• Aim to influence discussions in both academia and in policy making.


Why we need a new modeling framework

Conventional modeling framework treats:1. Macroeconomic phenomena (such as output) and

microeconomic issues (such as finance) separately.

2. All kinds of markets as perfect such that prices clear to ensure the full employment of resources. In this way supply drives the economy:

Does not take into account issues of inequality, unemployment etc.

Total spending on investment and climate mitigation is determined by available savings.

Full capacity utilization of resources, including labour, raises questions like: Will labour be fully employed if global warming significantly reduces the level of output?


Why we need a new modeling framework

Unconventional (Post) Keynesian Stock Flow Consistent (SFC) models provide an integrated approach to finance, income, production and wealth (Godley and Lavoie 2007).

SFC models: Investment decisions are not dependent on savings decisions

and financial institutions are a key component of the modeling framework.

Economic factors are not working in full capacity and income and wealth distribution has important effects on economic and financial stability .

BUT there is no role of the environment.Environmental models which take into account issues

like employment (ex. E3MG, LOW GROW) do not take into account the implications of the financial sector. Giovanni Bernardo – Giorgos Galanis - New Economics Foundation

General Framework

The economy consists of: • Firms which produce consumption and

investment goods. Firms also take loans from Commercial Banks.

• Two kinds of households which (i) work at the firms or (ii) own the banks. They receive wages and interest on loans which they consume in the full amount.

• Commercial Banks which extend loans to firms.• A Government which owns the stock of

Renewable Energy, collects Green Taxes and invests in Renewable energy and mitigation. The Government is able to implement rules on Credit Creation. Giovanni Bernardo – Giorgos Galanis - New Economics Foundation

Real- Financial Interactions (Main Assumptions)

• Savings do not lead to investment but it works the other way round.

• Investment decisions depend on the firms’ profits and on their propensity to invest.

• If the propensity to invest is higher than the current profits then firms ask for loans.

• Commercial banks create money when they extend a loan. This amount of new money is destroyed when the loan is repaid.

• Banks are not passive in extending loans as in most Post Keynesian models.

• Commercial banks extend loans based on their confidence on the ability of the firms to repay the loans.


How to include Environmental variables

1. Use of Energy in order to produce output.2. Relative use of Renewable and Non

Renewable Energy (D’Alessandro et all 2011).

3. Investment in Energy Efficiency and in Renewable Energy (Bernardo and D'Alessandro 2013 LINK).

4. Energy use – link with emissions.5. mitigation.6. Green Taxes.


http://www.foreurope.eu/fileadmin/events/Modelling_Conference/WWWforEurope_Modelling_Conference_Session_1_Bernardo.pdf

Three strategies towards a low carbon economy

Three strategies for a transition to a low carbon economy

1. Investment in renewable energy2. Investment in mitigation3. Investment in efficiency

Investment in mitigation represents the part of government spending that is allocated in order to increase the capacity of carbon sinks (eg. reforestation, soils, regenerate agriculture etc.) and also the R&D in technology such that the levels of are decreased per use of .

Investment in efficiency represents the part of the firms’ investment in order to use less energy per production unit such that= + , where represents the investment that does not go towards energy efficiency. Giovanni Bernardo – Giorgos Galanis - New Economics Foundation

Energy Use

We assume a closed economy Output Y= ++G, where is the total consumption of the

households. Also assume that Y= ε*E, where E is the energy that is

required for the production of Y and ε is energy efficiency Then E= (++G)/ε

(1.1) Assume that Energy consists of Renewable nuclear and

Non Renewable , such that . From (1.1) we can get a relationship between energy use,

Consumption, Investment and Government Spending - (1.2)


Further Assumptions

Assume that, in the Business as Usual scenario the proportion of the firms’ total Investment goes to investment in capital is constant, such that =*

Then the residual goes to investment in energy efficiency such that =*

G = + such that M=*G and that =)*G, where is constant as above.

This allows us to run simulations and study the effects of changes in the relative weights of the different kinds of Investment and the different kinds of Government Spending


Investment in Energy Efficiency and in Renewable Energy

Assuming no depreciation of the stock of , then = + * , where >0, is the effectiveness of in increasing .

Similarly, energy efficiency will increase with higher such that = , with >0. In this way, the rate of the increase of energy efficiency is diminishing every period. The use of this functional form aims to capture the technological limits of the effects of an increase in to .

Given the above (1.2) can be then expressed as - (1.3)


emissions

Assuming that emissions are produced by the use of then we can express the amount of emissions by the following relation

(2.1) where is a parameter that is able to capture the amount of emissions per unit of non renewable energy, such that , with In this way investment in mitigation can have a

long run limited effect in reducing the emissions in relation to the use of non renewable energy.


Green Taxes

Suppose that government introduces a tax for every ton of

will be paid both from Households (including bankers) and Firms relative to their respective use of energy such that the proportions are:

for workers households. for bankers households. for firms.


Simulations

We use simulations in order to study the relation between GDP and emissions in the following cases1. Business as usual.2. Green Taxes.3. Credit Guidance.4. Green Taxes & Credit Guidance.We study the above cases for both a stationary state and a balanced growth path.


Business as usual (BAU)


• This is our default scenario: a process of growth leading to a long-run steady-state.

• Growth is driven by the net creation of credit (Credit Creation minus Debt Repayment).

• Only a small percentage of money are invested in energy efficiency.

• No green taxes and no GCG.

Green taxes (GT)


• Suppose that the Government introduces a GT for every ton of GHG emission.

• In this simulation the parameter is equal to 0.02.

• The amount of GT will be invested by the government both in renewable energy and mitigation policies

• The result is that we will have an increase of the stock of RE and a decrease of

Green Credit Guidance (GCG)


• As we discussed above, the use of GCG imposes some control over the creation and allocation of new money.

• This restriction forces commercial banks to allocate a certain percentage of their loans for spending in energy efficiency.

• In this case we assume that so the 20% of the private invest must be spend in energy efficiency .

• As a result the parameter will increase.

Green Taxes & Credit Guidance


• In this last scenario we want to test a mix of the policy instruments.

• We assume that and

Comparison: Output


• Output is the same as in BAU and in GCG.

• This because the level of credit creation is the same, the difference concerns the allocation of the money.

• GT have a negative effect in output.

• This effect is smaller when GCG and GT policies are combined (as expected).

Comparison: GHG Emissions


• GCG has an effect to cutting down GHG emissions but without having a decoupling effect.

• GT have a faster reduction to GHG emissions and also achieve decoupling.

• Decoupling is also achieved with the combination of the two policies but in this case the reduction of the GHG emissions is lower than in the GT case.

Exponential growth scenario


• This graph represents the effects of the combination of both policies to GHG emissions, Non Renewable Energy and Output.

• In the exponential growth scenario, it is impossible to achieve a transition to a low carbon economy.

Concluding Remarks


• Use different forms of Energy and different forms of Investment can provide a link between SFC and Environmental Economics Research.

• Monetary Policy instruments can be used for climate change mitigation.

• In the case of a stationary state both GT and GCG can have important effects for the reduction of both the use of non renewable energy and the GHG emissions.

• The use of GT only is negative for output.• The use of GCG only, has limited effects on reducing GHG

emissions.• A combination of the two policies has the best overall effects in

the case of steady state growth.• In the case of a balanced growth path the same policies are not

efficient in reducing the GHG emissions and the use of non renewable energy.

Green credit guidance

Technology

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