Climate policies and external adjustment

This paper assesses the economic effects of global climate policies on external adjustment. Various climate policies could have substantially different impacts on external balances over the next decade. A credible and globally coordinated carbon tax would decrease current account balances in greener advanced economies and increase current accounts in more fossil-fuel-dependent regions, reflecting a disproportionate decline in investment for the latter group. Global interest rates would fall over time with increases in the carbon tax due to the fall in global investment. Green supply-side policies would increase investment and saving but have a more muted external sector impact because of the constrained pace of expansion for renewables or the nature of the infrastructure boost. Country characteristics, such as initial carbon intensity and net fossil fuel exports, ultimately determine the current account responses. The external adjustment depends crucially on the degree of international policy coordination.