Climate Change as a Source of Financial and Macroeconomic Risk

Abstract

Climate change is increasingly being recognized as a major source of both financial and macroeconomic risk, which go beyond its environmental dimensions. These risks include physical risks due to extreme weather events and long, term climate changes; transition risks related to climate policies, technological changes, and shifting market expectations, all of which have significant implications for asset valuations, financial stability, and economic performance. This paper reviews the economic literature with a focus on the narrative, which considers the origins of climate, related risks, their transmission through financial systems, and their effects on macroeconomic outcomes such as investment, output, and stability. The review identifies the major transmission channels of climate risk, i. e., physical risk, transition risk, and expectation, based channels, and explains how financial amplification mechanisms can convert climate shocks to systemic risks. Besides, the paper reviews the role of financial regulation, central banking, and coordinated policy frameworks in managing these risks. The study, by combining insights from financial economics and macroeconomics, conveys that the implementation of extensive policy measures is crucial not only to increase the economy's resilience but also to enable sustainable growth over the long term.