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Abstract

Interest rates are central determinants of saving and investment decisions. Costly financial intermediation distorts these price signals by creating a spread between deposit and loan rates.
This study investigates how bank spreads affect climate policy in its ambition to redirect capital. We identify various channels through which interest spreads affect carbon emissions in
a dynamic general equilibrium model. Interest rate spreads increase abatement costs due to
the higher relative price for capital-intensive carbon-free energy but they also tend to reduce
emissions due to lower overall economic growth. For the global average interest rate spread
of 5.1pp, global warming increases by 0.2°C compared to the frictionless economy. For a
given temperature target to be achieved, interest rate spreads necessitate substantially higher
carbon taxes. When spreads arise from imperfect competition in the intermediation sector,
the associated welfare costs can be reduced by clean energy subsidies or even eliminated by
economy-wide investment subsidies.