The climate-sovereign debt doom loop: what does the literature suggest?

Abstract

The current literature documents significant effects of climate change on the cost of sovereign debt and debt levels. These effects are due to a complex nexus of climate change systemic effects on the economy, characterized by deep uncertainty, fat tails, feedback loops, and uncertain fiscal costs of climate policies. Investors believe that climate risks have begun to materialize but are underpriced. I give an overview of the multichannels and review the evidence on fiscal costs from climate change, climate premia for sovereign debt, and climate risk assessments of sovereign bond portfolios. Recent advances integrate forward-looking climate scenarios in debt sustainability analysis and credit ratings. The findings suggest several mechanisms may activate a doom loop between climate change and sovereign debt.