Ecological stock-flow consistent (E-SFC) models provide a more realistic representation of the role of banks, the dynamic behavior of economic systems, the interplay between demand and supply, and the role of green investment than standard general equilibrium models used by Ministries of Finance.
E-SFC models are wellsuited to analyzing the macrofinancial and environmental implications of different policy scenarios, allowing MoFs to evaluate the trade-offs of environmental policies and identify environmental policy mixes that maximize benefits and reduce risks. This analysis includes the evaluation of carbon taxation, green subsidies, and green public investment.
- E-SFC models consider that banks create money endogenously and are crucial drivers of macroeconomic activity and investment. This representation can make green investment less costly than in DSGE and CGE models, where there is crowding out of investment.
- In E-SFC models, spending is not just a cost for the government and private sector but also a source of income that can increase economic activity and generate additional jobs with positive spillover effects, especially where unemployment is high.
- E-SFC models rely on a System Dynamics approach in which path dependency is an inherent feature, such that long-run outcomes depend on short-run outcomes.
- E-SFC models take underutilization of labor and capital into account, such that demand is an important driver of economic activity in both the short and long run. In general equilibrium models, by contrast, demand tends to play a role only in the short run or no role at all.
- MoFs should draw on scenarios produced by the Network for Greening the Financial System (NGFS) to develop country-specific scenarios, including by distinguishing between national and global green policies and considering the country-specific context of the green transition.
- E-SFC models are useful for scenarios of 5–10 years; longer time horizons require additional assumptions. They are not suited to short-run forecasting.
While there have been efforts to integrate E-SFC model characteristics into general equilibrium models— GEM-E3 integrates a more realistic financial system in the standard CGE structure, for instance—it remains difficult to integrate all features into a CGE model, and it is generally more complicated than in an E-SFC framework. Skills needed for developing E-SFC models include standard macro-modeling skills and familiarity with macroeconomic theories, familiarity with national accounting and environmental data, and a very good understanding of balance sheets. Partnerships with research institutions can be helpful, as long as building MoF capacity is the end goal.
Keywords
financial systemmodelspolicy mixpolicy simulationsystem dynamics