I read this new paper titled “Climate Minsky moments and endogenous financial crises” by the Bundesbank’s Kaldorf & Rottner suggests that indeed, a rapid green transition may be a source of instability in the financial system.
But long-term, climate policy might make finance more stable.
In this note I ask what happens if the model adds some further dimensions: specifically, not just carbon taxation to incentive abatement, but technology shocks, such as, for example negative emissions (as foreseen in UNFCC Article 6, specifically article 6.2 and 6.4 which are technology agnostic), or cognitive skill-biased technological change?
The paper is very elegant and clean. They develop a model in which suggests how a sharp increase in carbon taxes lowers the value of emissions-intensive capital, tightening financial sector leverage constraints and triggering potential self-fulfilling runs (instability) However, they suggest dynamic evolves over time. As carbon taxes reduce capital accumulation, the financial sector shrinks. A smaller, less leveraged system is more stable in the long run.
During the transition itself, a Paris-aligned carbon tax path raises the probability of financial crises sharply in the short term, especially if implemented abruptly. Over time, this risk subsides as the financial system adjusts.
Figure 2. Transition-induced crisis risk spikes early, then falls
Whether this transition appears “worth it” depends on how society values the future. That is, on the social discount rate.
How is this relevant to the US or the UK with highly developed financial service sector?
Countries with high discount rates—like the UK or US, where electoral cycles are short and policy myopia is more common—may see only the short-run costs. In such settings, transition-induced financial fragility looms large in decision-making. Even if the long-run gains are substantial, they are discounted away. The result: delay, hedging, or underpowered policy responses—despite model-based evidence of long-run benefits.
Extending the model
The model can be enriched in two directions that reflect real-world complexity at least in recent period.
First, allow firms to substitute between carbon taxes, direct abatement, and negative emissions. Offsets (e.g. DAC, BECCS, reforestation) become a third way to decarbonize—buying time and flexibility and potentially being embedded in a global system of trade. This is explicitly foreseen in the Paris Agreement under Article 6.
This mechanism mitigates the short-run decline in capital values and reduces immediate fragility. But it creates new challenges:
- Offset credibility and permanence
- Volatility in the price of removals
- Risk of policy reversal
Fragility is reshaped, not eliminated.
Second, incorporate a cognitive skill-biased technology shock. Suppose AI, smart infrastructure, and automation scale rapidly alongside climate action. Capital shifts not away from the economy, but toward high-skill sectors. The financial sector reallocates rather than contracts.
This maintains capital demand and even amplifies inequality. High-cognition workers benefit disproportionately; investment channels shift to innovation-intensive firms. You don’t get a smaller financial system—you get a more unequal and innovation-sensitive one. A particular concern is that the reallocation towards traded serv
The baseline BIS model yields sharp insights on transition fragility. But in practice, the story is conditioned by time preferences, institutional structure, and complementary shocks.
Understanding that conditionality is essential to designing credible, adaptive transition pathways.
Paper:
“Climate Minsky Moments and Endogenous Financial Crises”
Authors: Matthias Kaldorf & Matthias Rottner
BIS Working Paper No. 1248
https://www.bis.org/publ/work1248.htm