How the United States inflation reduction act drives climate finance globally

The United States (US) Inflation Reduction Act (IRA) is the most forceful climate policy action in the US history, aiming to reduce US emissions by 40% by 2030 relative to 2005 levels. Given a 50% emission reduction pledged under the Paris Agreement, the IRA is a major building block in achieving the US climate objectives. A combination of tax credits, grants, and loans worth at least $370 billion promises to accelerate the transition to net zero in the US by stimulating private sector investments in clean energy.1 At the same time, vast climate financing needs remain unmet not only in the US but also globally. Annual global climate financing needs are estimated at $10 trillion during the period 2030–2050, with only $2 trillion made available currently (Buchner et al. 2023). Against the backdrop of record-high post-pandemic debt levels and elevated borrowing costs, we ask how the IRA can alleviate climate financing constraints worldwide. We further ask how policy frameworks abroad can help harness any positive spillovers from the IRA. We highlight a novel international spillover channel of green industrial policies and show that global investment fund flows are an important conduit for translating the IRA into an increased supply of climate finance globally. Specifically, we document that the IRA triggered a shift in investor portfolios towards assets labeled as sustainable, leading the assets under management (AUM) of sustainable-labeled investment funds to grow significantly upon the IRA announcement.2 In contrast, conventional investment funds shrank (Figure 1a). International spillovers arise along two dimensions: First, higher inflows into sustainable investment funds are most pronounced for non-US domiciled investment funds. Second, these sustainable funds increased their cross-border portfolio investments, notably to non-US recipient economies. Thus, the IRA has helped raise climate finance worldwide. Recipient economies better prepared to address climate change benefited most from the additional portfolio investment inflows. Why does the IRA induce a shift in investor portfolios in favor of sustainable funds? The IRA is widely perceived as a major realization of transition risk. Following decades of legislative initiatives to address climate change, the IRA announcement signaled a credible US commitment to robust climate action and a faster transition to net zero. The immediate decline in climate policy uncertainty upon announcement is testament to the policy’s credibility as perceived by investors (Figure 1b). The ensuing rise in transition risk triggered a shift in investors expectations of future sustainable versus conventional investment funds’ cash flows. As highlighted by Pástor, Stambaugh, and Taylor (2021) and Ardia et al. (2023), cash flows from assets linked to conventional and carbon-intensive activities declined in expectation of tighter climate policies which may strand these assets or see them contested in climate litigation. In contrast, cash flows from assets tied to activities associated with the green transition were expected to rise as they benefit from targeted IRA support and a shift in consumer preferences towards more sustainable products. Moreover, the realization of transition risk may also have strengthened sustainability preferences of investors (Capotă et al. 2022). As Section 5 shows, investors were keenly aware of these shifts in expected cash flows and preferences in favor of sustainable assets, as evidenced by an immediate increase in the relative valuation (realized return) of sustainable funds. This is consistent with the shift to low-carbon assets induced by other major climate policy deals like the Paris Agreement, as documented by Monasterolo and De Angelis (2020), Alessi et al. (2023, 2024). A record increase in climate attention in the US when the IRA was announced confirms the immediate revaluation of sustainable assets in response to it. Investors paid close attention to the IRA as important policy action mitigating climate change-related risks (Figure 1c). We use the Google Search Volume Index for the term “green bond” as an alternative measure of climate attention and its link to sustainable debt capital markets. The spike in searches just after the IRA announcement confirms investor awareness of the change in transition risk.

source :

https://www.adb.org/publications/us-inflation-reduction-act-climate-finance