Business and Management Research News

In November the business and management department’s own Dr. Maria-Teresa Punzi traveled to Brussels to give an invited talk at the Directorate-General for Economic and Financial Affairs (DG ECFIN) of the European Commission. Dr. Plamen Nikolov invited her to give the talk and present one of her recent research papers.

WVPU: Was it hard to decide which facets of your research you would present at the European Commission?

Dr. Punzi: Initially, I wanted to present about household heterogeneity, which is a recurrent theme in my research, but at the last moment I decided to change course and present my work on climate change policy and environmental risk. I think that I was smart to trust my instincts, as those present at the European Commission seemed to enjoy the topic.

WVPU: Please tell us a little bit more about your presentation.

Dr. Punzi: To be more specific, I explained the dynamics of business cycle fluctuation by using a dynamic stochastic general equilibrium (DSGE) model which incorporates climate change policy. This environmental policy is introduced in the model by assuming that the government limits the use of polluting inputs during the production process. This phenomenon is usually known as cap-and-trade. My model’s simulation used data from the United States.
The results suggest that this type of climate change policy (cap-and-trade) reduces the positive effect that a technology shock would have in the economy. Moreover, some environmental policies could lead to defaults as cap-and-trade negatively affects the firms’ profitability and liquidity, decreasing the chance to repay back the loans acquired to finance the new production.

WVPU: Was that all you presented in your talk?

Dr. Punzi: I also presented the results of a two-sectors model case, i.e. a green sector and a brown sector. The two sectors differ in terms of their pollution inputs: the green sector uses clean and renewable energy, while the brown sector use fossil fuel energy. The climate change policy applied only to brown firms, and the model predicts that default rates can increase for both sectors. Indeed, the environmental policy spill over to the green sector through the banking system. Banks charge higher lending rates to all firms in order to avoid balance sheet distress, and higher lending rates increase the probability of default.

WVPU: Wow. That’s fascinating. What was your takeaway from a policy point of view?

Dr. Punzi: I discussed the role of monetary and macro-prudential policies. I suggested that there should be a more active role from policy makers and financial regulators in order to take into account the environmental risk to which the economy is exposed during the transition period of the implementation of climate change policies.

Many economists attended my talk, even researchers working at the Climate Change Division. These people are not focusing on business and financial cycle, but they understood the problem in terms of banking default and financial stability.

WVPU: Some may say that your research suggests cap and trade or other environmental policies could have short term negative effects on the banking industry or the economy as a whole. How do you respond to that?

Dr. Punzi: Overall, my research is not meant to discourage policy makers from implementing effective climate change policy. We all want clean air, less pollution and a better environment, but in the transition period the economy need better policies to avoid financial instability. Probably central banks could play a better role.