Bank of Canada releases new climate scenarios model

The Bank of Canada (BoC) released an analysis of the global economy that combines climate scenarios with existing climate-economy models. The study is one of the first to show climate policy pathways, and assess their distribution of transition and physical risks to the macroeconomy.

Scenario analysis is a tool recommended by the Task Force on Climate-Related Financial Disclosures as a way to examine the potential climate-related effects at uncertain levels of future greenhouse gas emissions. It is used in the development of strategic plans that are more flexible and robust to a range of potential emissions and the associated climatic consequences. 

The four climate scenarios analysed were:

1. A ‘business as usual’ scenario with no significant action to limit emissions.
2. A scenario in which countries meet their current nationally determined contributions (NDCs), as specified in the Paris agreement (which is insufficient to limit heating to 2°C by 2100).
3. A scenario in which countries act now to limit global heating to 2°C by 2100.
4. A scenario in which countries act from 2030 to limit global heating to 2°C by 2100.

Climate-economy modelling under these scenarios found that a delayed response to climate change (scenario 4) was consistent with an “extreme structural transformation of the economy with the largest sectoral shifts and GDP declines” over the shortest time period. In addition, there would be an “increased risk of stranded assets” compared to the other scenarios. 

Delaying climate action until 2030 would also require a carbon price of over CAN$600 per ton by 2050 if global heating were to be kept to 2°C. This compares with CAN$400 per ton if countries act now (scenario 3) and CAN$200 per ton if countries meet their NDCs, leading to increased heating of up to 2ºC (scenario 2).

The results of the analysis suggest a trade-off between physical climate risks (such as floods, wildfires and sea level rise) on one hand, and climate transition risks (such as carbon pricing, government policy and changing market sentiment) on the other. 

Inaction avoids transition risks, but at the cost of increasing physical damage, along with associated economic and social costs. In contrast, early action increases transition risk, but reduces global heating and its climatic effects. The study also shows that late action must be abrupt, and therefore disruptive, if it is to keep temperatures below dangerous levels. Earlier action, on the other hand, allows time for new technologies to enter the market and smooth the carbon transition, with lower transition costs.

The BoC is currently working with other members of the Network for Greening the Financial System on developing a standard set of climate-related scenarios for analysis by central banks.