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Abstract
This paper addresses the macroeconomic challenges stemming from the double affectedness of climate change and dependence on external finance in peripheral countries. The paper uses the Post-Keynesian concept of an asset’s own rate of return to assess how susceptibility to the combined effects of erratic capital flows and the vulnerability vis-à-vis the physical and transitional risks of climate change reduces macroeconomic policy space. Climate change and mitigation strategies are said to contribute to financial instability ensuing flight-to-quality of international investors. This translates into higher external financial fragility in low income countries with a high degree of commodity dependence—with increased exchange rate volatility and devaluating pressure deteriorating affected countries’ currencies’ liquidity premia and the expectation of their short-term exchange rates as result. Consequently, policy-makers in affected countries are forced to commit to investor-friendly policies and high interest rates to uphold their currencies’ acceptance. The susceptibility to the physical risks of climate change and mitigation hence contributes to the self-perpetuating nature of international monetary asymmetries and hierarchies.
Notes
1 Climate change is said to increase inequality levels because its burdens are disproportionately borne by poorer households and countries and the costs for climate mitigations and adaptions measures might be prohibitively high (Diffenbaugh and Burke Citation2019; Porter et al. Citation2014, 503; Roxburgh et al. Citation2020). This also holds for climate policies such as CO2-taxing: because of the high pass-through of carbon-pricing into wholesale electricity prices, CO2-taxes would also affect lower income groups more and hence aggravate inequality (Batten, Sowerbutts, and Tanaka Citation2020; Dennig et al. Citation2015). Climate-related impoverishments and the increased spending on mitigation and adaptation measures of consumers in the Global South weighs particularly heavy, as DEEs increasingly act as global outlet markets for manufactured goods.
2 Whilst Minsky’s writing was primarily concerned with balance sheets of private international investors (e.g. Minsky Citation2004), more recent literature focuses on public balance sheets, as is done in this paper.
3 We would like to thank an anonymous reviewer for highlighting this.
4 In carry trade transactions, debt in low-interest bearing core currencies (funding currencies) is taken out and reinvested in short-term assets denominated in high-interest bearing peripheral currencies (asset currencies). This is done to profit from higher interest and in the hope of favorable (that is upward pressure on the local currency) exchange rate developments—which is often a self-fulfilling prophecy when the volume of carry trade is large relative to the size of the economy (Bonizzi, Kaltenbrunner, and Powell Citation2019, 9; Bortz and Kaltenbrunner Citation2018, 380).
5 Similarly, Harvey (Citation2009, 42) highlights that the mere declaration of a current account deficit is more performative in putting pressure on the exchange rate than the deficit itself.
6 The adverse effects of large-scale capital outflows was demonstrated in the Latin-American and Asian debt crises in the 1980s and 1990s (see e.g. Arestis and Glickman Citation2002; Eichengreen Citation2004) as well as the financial crisis 2007/2008 (e.g. Sindzingre Citation2012) and more recently the Covid-19 crisis (e.g. Hofmann, Shim, and Shin Citation2020). In fact, the Asian crises in the 1990ies can be explained by the interlocking of early and late Asian industrializers via carry trade (Ramos Citation2019, 644).
7 Here central banks buy up FX flowing into the country which are then “parked” in low-yielding government bonds issued by centre countries. This is done in the attempt to counter the sudden appreciation of the domestic currency to protect the export sector for instance. Sterilization policies are yet another demonstration of the conflicting policy objectives peripheral countries face: When conducting sterilization policies, central banks risk inflationary pressure, which is already effectuated by the additional demand induced by the capital inflow. When the heightened inflation is fought against by raising the policy rate, the domestic economic development is stifled and the export sector harmed due to loan crunches—hence the initial policy trajectory is reversed.
8 Recent research also points out to the dangers implied in green infrastructural projects as they are currently designed (Müller Citation2020; Gabor Citation2019).