How Do We Achieve a Sustainable Economy?
Modelling Transition Risk
Modelling Transition Risk (TRansit): Towards an Agent-based, Stock-flow Consistent, Input-output Framework
Principal Investigator: Professor Tim Jackson
Tim Jackson is Director of the Centre for the Understanding of Sustainable Prosperity (CUSP), and Professor of Sustainable Development at the University of Surrey. He’s served as an advisor on sustainability to commercial, government and intergovernmental organisations, including Economics Commissioner on the UK Sustainable Development Commission from 2004-2011. From 2010 to 2014 he was Director of the Sustainable Lifestyles Research Group (SLRG), which aimed to develop evidence-based advice to policy makers about realistic strategies to encourage more sustainable lifestyles.
Co-Investigators: Andrew Jackson (Surrey), Tim Foxon (Sussex), Tommasso Ciarli (Sussex), Marco Valente (L’Aquila University, Italy), and Florian Botte (University of the Littoral, France)
The aim of this project was to develop an agent-based, stock-flow consistent (AB-SFC) macroeconomic model and demonstrate its applicability to the modelling of transition risk, in the context of mitigating climate change.
The work follows recent proposals in the literature that AB-SFC models are precisely what is needed in order to address what the Bank of England’s chief economist, Andy Haldane, has called ‘macroeconomic questions where complexity, heterogeneity, networks, and heuristics play an important role’. The Transition Risk (TRansit) model developed in this project answers that call. Specifically, the 18-month project developed a beta version of a closed, demand-driven AB-SFC model with a high degree of complexity, heterogeneity and endogeneity. The model was then used to explore the economic, social and financial stability implications of a transition from brown (fossil-fuel) to green (eg renewable) energy during a rapid transition towards a net zero carbon economy.
The version of the TRansit model reported here remains a work in progress. The theoretical complexity of the task was in itself considerable. The multiplicity of heterogeneous agents that characterises AB approaches and the strict financial accountability inherent in SFC modelling, taken together, impose a set of stringent validation criteria on each iteration in the development of an AB-SFC model. The endogenous generation of a stable reference scenario representative of a mature industrial economy also imposes a significant ‘entrance barrier' to a useful model.
A fundamental lesson learned during this process, in keeping with the Keynesian tradition from which SFC modelling springs, concerns the important stabilising role played by the government sector. As a large, relatively homogeneous economic actor in a universe of much smaller, heterogeneous agents, operating under conditions of uncertainty, incomplete information and bounded rationality, our model confirmed suggestions that government has the potential to operate as a powerful ‘automatic stabiliser'.
The project also demonstrated the ability of an AB-SFC framework to simulate the complex, emergent behaviour of a mature, industrial economy under conditions such as those that are likely to be encountered during a transition towards net zero carbon. In doing so, we could illustrate several key mechanisms through which transition risks (and opportunities) are transmitted and show how the interactions between these mechanisms lead to a variety of economic, social and financial stability outcomes.
For example, our initial simulations illustrate how energy price rises and increased green investment can represent opposing forces on aggregate demand during the initial phase of a fast transition from brown to green energy. More importantly, we identified circumstances under which a variety of factors arising from these opposing forces compound each other in practice and lead to the ‘pro-cyclical crystallisation of losses' warned of by the former Bank of England governor, Mark Carney. We also highlighted the risk that such conditions can lead to higher income inequality.
Future work will improve the calibration and validation of the model and simulate a wider set of transition pathways towards a net zero carbon economy. We will also explore policy options to mitigate transition risks. The broad framework developed for this project provides a solid foundation from which to explore these more sophisticated policy analyses. The TRansit model is available to those wishing to build on our work.
Modelling Transition Risk Towards an Agent-Based, Stock-Flow Consistent Framework
Florian Botte, Tommaso Ciarli, Tim Foxon, Andrew Jackson, Tim Jackson, Marco Valente | February 10, 2021