Climate Change Emerges as a Core Macroeconomic Risk Reshaping Markets and Investment Decisions

Climate change is increasingly shaping the economy in ways that extend well beyond environmental damage, influencing how financial markets price risk and how companies decide when—and where—to invest. Davide Avino, Rongxin Chen and Hafiz Hoque argue that climate risk should be treated as a macroeconomic and financial variable, not simply an ecological concern.

That view sits in the middle of an active policy dispute. In the United States, the Trump administration sought to downplay climate-related risks in financial regulation and economic policymaking. In the United Kingdom, officials at the Bank of England have warned that climate change could pose mounting threats to economic stability, including through supply-side disruptions that can push up prices—precisely the kind of inflationary pressure central banks must respond to.

The policy stakes are rising because governments and central banks are already grappling with weak productivity growth, subdued business investment and uncertainty about the long-run path of interest rates—topics flagged in assessments from the Organisation for Economic Co-operation and Development and the Bank of England. Meanwhile, international bodies such as the Network for Greening the Financial System and the International Monetary Fund have increasingly highlighted climate-related financial risks as potential sources of broader macroeconomic and financial instability.

Against that backdrop, a key empirical question remains: does climate risk measurably affect economic outcomes? New evidence suggests the answer is yes.

Drawing on decades of data from US publicly listed companies and US Treasury markets, the researchers find that climate risk has become an increasingly important factor shaping both corporate investment and the wider financial conditions that influence those investment choices. In their framing, climate risk operates as a macroeconomic force: it affects how much firms invest, how investors allocate funds across companies, and even the “risk-free” interest rates that form the foundation for pricing assets throughout the financial system.

Corporate investment is a central driver of future productivity and economic growth. Decisions about factories, equipment, technology and research can lift output for years, but they are often difficult or costly to reverse. That irreversibility means uncertainty matters: when risks rise, firms frequently delay committing capital.

To quantify climate-related uncertainty, the researchers use a climate risk index developed by Robert Engle and colleagues, constructed from climate-focused news coverage. Using this measure over more than 30 years, they examine how shifts in climate risk correlate with changes in capital spending among listed firms.

The pattern is consistent: when climate risk rises, investment falls. A one-standard-deviation increase in climate risk is linked to an roughly 8% drop in capital expenditures in the following quarter relative to the typical investment rate. The effect is not fleeting. Instead, it remains statistically meaningful for several years, indicating a persistent drag rather than a short-term wobble.

One mechanism helps explain the result: climate risk raises the cost of capital. If investors perceive firms as more exposed to climate-related threats—whether physical risks, transition risks or regulatory changes—they require higher returns to compensate. Higher required returns translate into more expensive financing, which means fewer projects clear companies’ internal profitability thresholds.

The effect is stronger for firms that are already financially constrained. When external funding is hard to access, a rise in climate risk is more likely to trigger postponed or cancelled investment plans. In that sense, climate risk behaves like other forms of uncertainty—but the researchers find it appears to generate larger and longer-lasting consequences.

Why it matters

If climate risk raises financing costs and suppresses investment, it can weigh on productivity growth and long-term living standards—issues already troubling policymakers. The findings also imply that central banks and regulators cannot treat climate as a niche concern, because it may influence the baseline interest rates and financial conditions that shape the whole economy. The next question to watch is how these effects evolve as climate shocks intensify and as policy responses accelerate the transition to lower-carbon activity.