N°24-15: Sovereign Debt Sustainability, the Carbon Budget and Climate Damages

This paper investigates the trade-offs between managing the financial sustainability of public debt and addressing climate change. Mitigation efforts and increasing temperatures imply economic costs that reduce countries’ growth rates, respectively in the short and in the long term. This can make the repayment of outstanding debt more difficult. I explore and quantify the evolution of debt limits –maximum sustainable debt-to-GDP– for advanced economies, under various scenarios, which respect, or not, the carbon budget constraints of the Paris Agreement. Various scenarios are analysed according to the costs of emissions’ abatement and the political coordination among countries in the transition. The evidence shows that failing to enforce a slowdown in emissions at a global level, and to stabilize climate damages, generate plunging debt limits in the medium-long term and shrinking fiscal spaces for all countries, even for the few ones actuating the transition. On the contrary, if the green transition is coordinated globally, debt limits converge to stable and higher levels, despite an initial and temporary decrease, given by the negative impact of emission reductions on GDP growth rates. From the evidence presented, it results as significantly more beneficial for countries to collaboratively and promptly transition towards mitigating climate impacts on growth and fiscal spaces. This will support sustainable public debt and the potential to finance the green evolution of our economies.