Exploring the Evidence on the Association between Monetary and Financial Policy Shocks and Climate Finance: The Case of the Small Island Developing States

Small Island Developing States (SIDS) are heavily impacted by climate change despite their very limited contribution to global greenhouse gas emissions. While existing research predominantly focuses on local climate policy, the potential role of monetary and financial policy in influencing international climate finance – used for climate adaptation and mitigation purposes – remains unexplored. SIDS rely significantly on such international climate finance to address climate challenges due to their limited local funding capabilities. We examine how monetary and financial policy in SIDS affects international climate finance, analyzing data from 25 SIDS between 2000 and 2020. Using a local projections approach and an Augmented Inverse Propensity Weighted estimator, we find that both expansionary monetary and financial policy shocks are linked to decreases in climate finance. These findings suggest that monetary authorities and financial stability committees in SIDS should consider the impact of their policies on international climate finance, as policy shocks may hinder their climate adaptation and mitigation efforts.