The Carbon Bubble: Climate Policy in a Fire-Sale Model of Deleveraging

Credible implementation of climate change policy requires large fossil fuel asset write-offs. We discuss the implications of this issue, named the Carbon Bubble, for macroeconomic policy and for climate policy itself. We embed the Carbon Bubble in a macroeconomic model exhibiting a financial accelerator: if investors are leveraged, the Carbon Bubble precipitates a fire-sale as investors rush for the exits, and generate a large and persistent fall in output and investment. We investigate policies which can accompany the writing-off of these assets, like debt transfers, investment subsidies, government guarantees. We find a role for policy in mitigating the Carbon Bubble.