Macro-Fiscal Implications of Adaptation to Climate Change

DISCLAIMER: The IMF Notes Series aims to quickly disseminate succinct IMF analysis on critical economic issues to member countries and the broader policy community. The IMF Staff Climate Notes provide analysis related to the impact of climate change on macroeconomic and financial stability, including on mitigation, adaptation, and transition. The views expressed in IMF Staff Climate Notes are those of the author(s), although they do not necessarily represent the views of the IMF, or its Executive Board, or its management. This Staff Climate Note is part of a series of three Notes (IMF Staff Climate Note 2022/001, 2022/002, and 2022/003) that discuss fiscal policies for climate change adaptation. The first Note (Bellon and Massetti 2022a, henceforth Note 1) examines the economic principles that can guide the integration of climate change adaptation into fiscal policy. It argues that climate change adaptation should be part of a holistic, sustainable, and equitable development strategy. To maximize the impact of scarce resources, governments need to prioritize among all development programs, including but not limited to adaptation. To this end, they can use cost-benefit analysis while ensuring that the decision-making process reflects society’s preferences about equity and uncertainty. This second Note discusses the macro-fiscal implications of climate change adaptation. A third Note (Bellon and Massetti 2022b, henceforth Note 3) considers how to translate adaptation principles and estimates of climate impacts into effective policies. It argues that adaptation solutions can be guided by an extension of the IMF’s (2019b) three-pillar disaster resilience strategy to address changes in both extreme and average weather, for all countries. It suggests that public financial management (PFM) institutions can support an efficient implementation of adaptation solutions by factoring climate risks and adaptation plans into budgets and macro-frameworks, and in the management of public investment, assets, and liabilities. A review suggests adaptation needs while being challenged by limited fiscal space, limited capacity, or both, calling for additional support from the international community. To help guide national fiscal policies, countries could integrate climate risks and the cost of adaptation into their macro-fiscal frameworks. Shock scenarios are useful to reflect short-term impacts of climate disasters, while the long-term analysis of risks and uncertainties surrounding climate change requires scenarios that cover impacts from changes in both average and extreme events, as well as adaptation policies. Desmet and others show that relocation, in the form of migration and the rise of new productive clusters away from exposed coasts, is an effective adaptation strategy and can reduce GDP losses by a factor of 10. For Suriname, their model predicts annual costs below 0.3 percent of GDP and migration outflows that would reduce population by 2.4 percent by 2200. Taken together, these studies highlight the important role of adaptation policies in long-term scenarios, the need to explain adaptation assumptions in projections, and suggest that a well-planned gradual approach starting now can be cost effective. the Investment, and model of to analyze natural disasters and adaptation infrastructure. The DIGNAD model, developed in and a dynamic low-income or emerging-country open-economy model that incorporates natural disasters and resilient infrastructure to examine the nexus between public investment and growth, different financing strategies (external concessional, external commercial, and domestic), and fiscal reaction rules. It captures high rates of return on public capital, either standard or resilient, as as significant inefficiencies in public investment and capacity constraints, are pervasive in developing economies. model captures the main mechanisms and policy issues of interest for debt sustainability analysis, those associated with the linkages between public adaptation investment, economic growth, and debt. (1) during increase risk premium for borrowing costs. Investment in adaptation costlier investment in infrastructure the inflicted natural seawalls) marginal other