A climate-driven "Minsky Moment"

Revisiting the impact of a sudden repricing of carbon prices

In an earlier article I looked at the ‘extreme’ situation whereby policymakers are forced to push the price of carbon significantly higher and much sooner than everyone expects.

Instead of expecting (or hoping) that a gradual rise in the carbon price would be sufficient to accelerate the energy transition and decarbonise the economy, rapid climate change coupled with a lack of action by governments dealing with other pressing issues may mean that a significantly higher carbon price is required.

No longer the “slow policy ramp”. In this scenario time compression means extreme measures are required. Governments will have to “stamp on the brakes” and force carbon prices higher.

Analysis by Kempen Capital Management estimated that in the event of a sudden carbon tax of $150 per tonne, global financial markets could fall by as much as 41% with US equities likely to experience even greater losses.

What happens if policymakers are forced to "stamp on the brakes" and force carbon prices higher?

Although it’s impossible to know how and under what circumstance policymakers may be forced to ramp up climate policy action, one way of thinking about it is the probability that the climate reaches a “Minsky Moment”.

The term “Minsky Moment” was named after Hyman Minsky, an economist who argued that markets have innate characteristics of being unstable. Periods of stability are only ever transitory since households, governments and investors become complacent. This then sets the stage for a sudden increase in volatility as risks that had gone unnoticed or ignored suddenly become important.

A climate driven “Minsky Moment” would represent a tipping point from a period of stability, to one of instability, one that forces policymakers into more and more aggressive action including a rapid upward trajectory for carbon prices.

A recent report examined the impact of a sudden repricing of carbon prices including the impact on energy consumption, economic growth, government’s fiscal position and finally the implications for financial markets. Not simply focusing on the first order consequences, investors should always be on the look-out for the knock-on impacts.