At its core, climate change affects our economy through two risk channels. Physical risks – such as heatwaves, floods, droughts – can damage capital stock, reduce labour supply and productivity, and affect consumption and investment, including via disruptions to global trade flows (Costa and Hooley 2025). Transition risks, arising from the shift towards a low-carbon and climate-resilient economy, entail structural changes in investment, production, and consumption patterns. In turn, these changes influence public budgets – shaping revenues and spending patterns (Thygesen et al. 2022).

These two risks are not independent of each other and tend to interact (Batten et al. 2020). Without effective mitigation and adaptation, physical risks worsen. Delayed action requires more abrupt and costly policy responses in the future. Conversely, early and well-designed actions can reduce future physical damages and their associated costs. This highlights the need to provide a forward-looking and comprehensive macro-fiscal assessment of climate change (Salmon-Genel 2025).

In recent work (Gagliardi 2025), I present a stylised approach that embeds climate-related physical and transition risks into the European Commission’s Debt Sustainability Analysis (DSA) framework. The analysis provides country-level projections of public debt, primary balances, and key fiscal components (green investments, climate-induced economic losses, and revenue losses) over the period 2025–2050.

A stylised macro-fiscal framework for climate risks

Climate economic analysis is characterised by high uncertainty. This reflects multiple unknowns: the evolution of climate policies and global emissions, technological and behavioural responses, complex climate-economy feedback effects, and the risk of non-linear tipping points (Tamminen et al. 2022). Scenario analysis provides a practical framework to explore alternative macroeconomic and fiscal paths under different climate and policy assumptions (Aerts et al. 2024).

In my analysis, two forward-looking scenarios are considered:

• A ‘no further action’ (NFA) scenario, reflecting unmitigated climate change and no increased ambition in climate policies (in both the EU and rest of the world).
• A ‘net zero’ (NZ) scenario, entailing early and large mitigation action (in both the EU and the rest of the world) to achieve climate neutrality.

The analysis does not seek to rank policies, but to isolate how alternative climate pathways affect macro-fiscal trajectories relative to a baseline which does not consider climate impacts. Physical risks evolve according to scenario-specific assumptions, while mitigation policies are captured through two stylised shares of public-private investment needs uptake (10% public-90% private; 20% public-80% private). On the revenue side, two alternative approaches are considered, ranging from purely output-driven effects to scenarios with structural energy-tax base erosion.

Climate change and debt sustainability

The fiscal consequences of unmitigated climate change are illustrated in Figure 1, which shows the net fiscal impact of climate change under the ‘no further action’ (NFA) scenario relative to the ‘net zero’ (NZ) pathway, using different assumptions on the revenue side (panels A and B, respectively).

Figure 1 Net fiscal impact: ‘No further action’ vs ‘net zero’ in 2050 (% of GDP) 

Note: The net fiscal impact (% of GDP) is given by the difference in primary balance (and its sub-components) between the NZ and NFA scenarios for the EU aggregate. Negative values reduce fiscal pressure; positive values increase fiscal pressure. Projections shown in Figure 1 assume a 10% uptake of investment needs by the public sector. In Panel A (left), an output-driven revenue approach is followed. In Panel B (right), an output-driven revenue approach is combined with assumptions on structural energy-tax base erosion.
Source: Gagliardi (2025).

Results point to a clear intertemporal trade-off between short-term fiscal costs and long-term savings. Under the assumption of output-driven revenue changes, achieving net zero requires an upfront fiscal effort – primarily reflecting higher investment needs – but substantially reduces the macro-fiscal burden over time by limiting the compounding effects of climate damages. At the EU aggregate level, by 2050, investment needs worsen the primary balance by less than 0.1% of GDP, while avoided economic losses from physical risks and associated revenue losses exceed 0.4% of GDP, resulting in a net fiscal gain of around 0.4% of GDP. A somewhat larger short- to medium-term deterioration is observed under higher public sector investment uptake, although a net fiscal gain still emerges by 2050.

Under an alternative revenue assumption combining output-driven effects with structural tax base erosion, long-run fiscal gains persist but are smaller and accompanied by a weaker medium-term profile. This reflects the faster decline in fossil fuel-related tax revenues under the net zero pathway, which temporarily amplifies fiscal pressures. Nevertheless, avoided climate damages and lower economic losses continue to dominate, yielding a positive net fiscal impact of around 0.3% of GDP by 2050. These results are robust across alternative assumptions on public and private investment shares.

Some caveats and limitations should be highlighted. The projections of economic losses from physical risks are subject to considerable uncertainty. Static adaptation levels are assumed. Overall, results depend on compliance with climate mitigation action by countries outside the EU. On the transition side, simplified assumptions are taken on investment needs. Moreover, our analysis does not detail shifts in the energy mix and the tax bases of alternative energy carriers. As such, the results should be viewed as stylised illustrations rather than forecasts.

Policy implications

Climate change has significant and persistent effects on macro-fiscal trajectories. Integrating climate risks into fiscal frameworks is important to ensure credible public finances, support a smooth transition to a climate-neutral economy, and build macro-fiscal resilience to large structural changes and rising climate impacts.

The high level of uncertainty points to the usefulness of using scenarios to illustrate how physical risks and transition dynamics might interact over long horizons to shape fiscal outcomes.

Fiscal sustainability outcomes in the medium and long term will increasingly depend on how countries manage the intertemporal trade-off between near-term transition costs and longer-term macro-fiscal outcomes. This highlights the central role of targeted public investment, revenue composition, and growth strategies to support the structural transformation of the economy.

More broadly, the analysis underscores that concerted mitigation and adaptation action towards ambitious global and EU climate targets remains essential to reduce countries’ exposure and vulnerability to climate change and strengthen resilience.

Disclaimer: The views expressed in this column are solely those of the author(s) and should not be considered as representative of the European Commission’s official position.

References

Aerts, S, L Stracca and A Trzcinska (2024), “Economic losses from climate change are probably larger than you think: New NGFS scenarios”, VoxEU.org, 22 October.

Batten, S, R Sowerbutts and M Tanaka (2020), “Climate change: Macroeconomic impact and implications for monetary policy”, in Ecological, Societal, and Technological Risks and the Financial Sector, Springer.

Costa, H and J Hooley (2025), “The macroeconomic implications of extreme weather events: Insights from advanced economies”, VoxEU.org, 31 October.

Gagliardi, N (2025), “The Macroeconomic and Fiscal Impact of Climate Change in the EU: A Stylised Approach”, European Economy Discussion Paper 237, European Commission.

Salmon-Genel, M (2025), “Assessing the Macro-Fiscal Risks from Climate Change: Concepts, Methodological Approaches, and Insights from Country Practices”, European Economy Discussion Paper 224, European Commission.

Tamminen, S, T Leinonen, O Haanperä, S Puroila and T Puroila (2022), “How to Scope the Fiscal Impacts of Long-Term Climate Strategies? A Review of Current Methods and Processes”, Coalition of Finance Ministers for Climate Action, Washington, DC.

Thygesen, N, J Malzubris, M Szczurek, L Jankovics, M Larch, M Gabrijelcic, X Debrun, M Busse, M Bordignon and R Beetsma (2022), “Public finances and climate change in the post-pandemic era”, VoxEU.org, 16 March.