Modelling the climate change–sovereign debt doom loop 

By Professor Stavros Zenios from Issue 15

Imagine a world where rising temperatures don’t just threaten ecosystems, but also the financial credibility of nations. For many countries, climate change is no longer a distant environmental risk; it’s a potential fiscal crisis. Slower economic growth and increased frequency of natural disasters can strain revenue and expenditure, leading to raised government borrowing costs in response to these risks, creating a doom loop where climate shocks and debt distress reinforce each other.  

To understand and prepare for this emerging threat, we’ve built models that combine insights from climate science, economics and public finance. Working with colleagues from climate economics, we’ve developed a model for testing how future climate scenarios could affect the sustainability of sovereign debt. 

Figure 1 displays the steps of our approach. We take a model-based, data-driven multidisciplinary view to link narrative scenarios of coupled climate–economy models in the tradition of Nobel laureate William Nordhaus with debt sustainability analysis (DSA). The narrative scenarios of climate trajectories provide the basis to calibrate scenario trees of economic, fiscal and financial determinants of debt. A large-scale optimisation model trades off debt financing costs with refinancing tail risk to project future debt trajectories and assess sustainability with a high confidence level. The interlinked models translate climate science into a credible sovereign risk metric for policymakers. 

The road has been challenging, but is starting to produce results.  

In one project, we’ve linked a state-of-the-art climate model (RICE50+ of Gazzotti at al. 2021) with different damage functions from a large literature to study climate effects on debt and potential benefits from adaptation strategies. We stress-test sovereign debts under combinations of ‘shared socioeconomic pathways’ (SSPs) and ‘representative concentration pathways’ (RCPs), which describe future greenhouse gas emission trends, and based on different assumptions about how rising emissions will affect economic growth. Two possible future pathways from the IPCC are known as SSP2-RCP4.5 and SSP3-RCP7.0. The former assumes that socioeconomic trends will follow historical patterns and that the impact of greenhouse gas emissions will be moderate. The latter assumes that there will be international fragmentation, as observed in current geopolitical conflicts, combined with relatively high greenhouse gas emissions, leading to a median temperature rise of up to about 3.4 degrees Celsius by 2100. Coupling RICE50+ with DSA, we project debt growth for several countries. Figure 2 illustrates results for different climate narratives.  

Starting from these results, we can carry out very rich analysis to answer questions with policy implications: 

1. Are the projected debts sustainable? If not, what kind of fiscal adjustments are needed to avoid debt crises?
2. Can investments in adaptation mitigate the projected debt increases? If yes, how much of the investment can be publicly funded before the costs overtake the benefits?
3. Can governments maintain a constant level of public spending while maintaining sustainable debts in the long run? 

The answers aren’t simple, but they are actionable. For example, we found that adaptation can have beneficial effects, but governments can only finance about 1/3 of the total cost and break even. The private sector has to carry the rest. Further detailed analysis can be found in a working paper published by the Bruegel think tank in Brussels (Calcatera et al. 2025). 

This kind of integrated modelling helps policymakers grapple with a fundamental challenge: how to manage the transition to a climate resilient future without triggering a financial crisis along the way. The ice beneath sovereign finances is getting thinner. We need to move carefully and decisively before it cracks.