UC Santa Cruz

In this dissertation, I study the financial impact of climate change through bank lending, sovereign default risks, and household consumption behavior. With intensifying climate change risks, financial institutions minimize potential losses by lending less to borrowers with higher vulnerability to such risks. These borrowers include not only businesses, but also national governments. Chapters 1 and 3 illustrate the credit contraction and financial distress that borrowers may experience. In particular, certain sovereign borrowers' difficulty in accessing funding is exacerbated by their inability to effectively adjust revenue and expenditure. While the results documenting the effects of climate change are about the financial sector, the impact may spill over into other parts of the economy as well. Chapter 2 results show that when sovereign default risks rise, there is likely household consumption loss. Chapters 2 and 3 together suggest that when climate change increases sovereign default risks, there are important implications for household behavior as well.

The agricultural sector is particularly susceptible to the impact of climate change. In Chapter 1, I investigate how vulnerability to climate change affects U.S. farms' credit access, and demonstrates that such impact is unequally distributed across farms. I first construct a theoretical framework of bank lending to farms faced with climate risks, and the model helps discipline ensuing empirical analyses that use novel panel datasets at county and at bank levels. I find that higher exposure to climate change, measured by temperature anomaly, reduces bank lending to farms. Such impact is persistent, nonlinear, and heterogeneous. Small and medium farms almost always experience loss of loan access. In comparison, large farms see less severe credit contraction, and in some cases may even see improvement in funding. While small banks continue to lend to small farms, their limited market share cannot compensate for the reduction of lending from medium and large banks. These results suggest that factors such as farm size and bank type can amplify the financial impact of climate change.

In Chapter 2, I uncover how sovereign debt default risks spill over into household consumption behavior through the fiscal channel. Existing studies have sparsely documented the consumption implications of sovereign default. During sovereign financial distress, a government typically conducts fiscal adjustment in areas such as pension and food assistance. Thus for households who benefit from public transfers, the adjustment of public expenditures matter for their consumption behavior. Using micro-level data of the National Survey of Household Income and Expenditure (ENIGH) of Mexico, I measure household consumption changes resulting from fiscal adjustment and from sovereign risks. The analyses consist of state-level and household-level estimates, and provide nuanced views of the default-consumption link by exploiting micro variables such as household income distribution, wealth, and socio-demographic characteristics. Both the state-level and household-level results suggest that in many cases, the link between default risk and household consumption is negative and significant, especially through the adjustment of pension expenditure.

Responding to climate change poses increasingly high fiscal costs. In Chapter 3, I examine how climate change affects sovereign default risks and fiscal policy through a set of empirical results and a stylized model. Using panel data of 135 countries over 1995-2018, I first show that 1 percentage increase of vulnerability to climate risks can increase sovereign default probability by around 5 percentage points, and such default risks may differ by fiscal conditions. More specifically, fiscal conditions refer to whether and how a government can conduct tax and expenditure adjustment to respond to aggregate shocks. The stylized model of sovereign default also shows that the risks of climate change raise default probability. Moreover, if a government has high fiscal rigidity, it also raises the default probability, thus potentially amplifying the costs of climate risks. Such results point to the importance of structural reform to reduce a government’s debt vulnerability resulting from climate change.