Exogeneity in climate econometrics

Abstract:

Human activity affects the Earth's climate while itself being affected by climate change. To empirically estimate the impact of humanity onto climate and vice versa, climate econometrics has emerged as a field split into two strands: one side focusing on conditional models of the economic impact of climate change, taking climate as given. The other side empirically models climate, taking economic and human activity as given. However, economic and environmental systems are determined with feedback in both directions. Here I examine one way to reconcile the two strands of climate-econometric research by considering a full (albeit simple) empirical climate-economic system and the conditions under which the system can be studied by only looking at the conditional economic or climate side alone. Weak exogeneity is necessary for valid conditioning, strong exogeneity – required for conditional forecasting – lends itself to the concept of climate-takers and climate-setters (countries measurably affecting local climate), while super-exogeneity can be interpreted as policy invariance for the economic impact side, and as a ‘no-tipping point’ condition on the physical side. An application to a stylised climate-economic system using temperatures, SO₂ emissions, and global forcing highlights how these concepts can be applied in practice. A system analysis in climate econometrics allows us to move towards fully-coupled empirical climate-economic models accounting for the necessary feedback to obtain empirical estimates of the impact of climate on humanity and vice versa.