Investment, capital accumulation and the role of money in national energy economy models used for assessing climate and energy policy

: This paper reviews national macroeconomic models that assess the impact of climate change mitigation and related energy policies. It highlights a notable deficiency in efforts to model capital accumulation given the potential for financial instability. In Australia, Computable General Equilibrium (CGE) models are typically used for assessing climate and energy transition policy. These models assume market-clearing and full employment in all sectors so that increasing public investment leads to the ‘crowding out’ of private sector activity, along with negative impacts (in terms of gross domestic product and welfare measures) derived from climate-related policy interventions. However, the majority of these models make the assumption that investment can be financed only either by taking funds sourced from other sectors of the economy, or by increasing rates of saving. This is not necessarily consistent with how the financial system works in reality, as demonstrated by the practice of implementing interest rate policy which would have no impact in these models. The radical transformation of the global energy system required to achieve net‐zero carbon emissions in 2050 hinges on a significant expansion in both public and private investment. Accordingly, the current suite of models has limited contribution to current policy debates, sitting, as they do, at odds with the observed reality. As such, there is a need for models which can accommodate these realities. In this paper, we present Stock-Flow Consistent (SFC) modelling as one possible and promising modelling tool which is more empirically grounded than current suites of policy models. In contrast to CGE models, the proposed modelling approach is broadly consistent with theories with better institutional details and policy interventions on the part of the government with richer behavioural assumptions rather than seeking to impose simplistic and unrealistic theory. In SFC models, money and credit play a central role due to the presence of more realistic linkages of the real economy to financial markets. These models embrace the assumption of endogenous money creation, rejecting the idea of rational profit or utility maximising firms and consumers, and can accommodate interventions associated with the “challenge-oriented” policies advocated by progressive analysts in the US and Europe. In this approach, the monetary system functions in accordance with the statements of central bankers who state that ‘credit money is created endogenously via loan origination’ Mcleay et al. (2014) & RBA (2023).