The Inflation Reduction Act of 2022 (IRA) is widely considered to be the most ambitious climate policy action in U.S. history. Over the next decade and beyond, a broad array of new tax credits and direct government expenditures will provide substantial support for clean technologies and industries, as well as direct incentives for U.S. households and firms to invest in the equipment and capital needed to reduce their carbon emissions. The financial sector will play a key role in financing this green transition, and forward-looking financial markets can provide a useful early indication of the IRA’s success. We take a climate finance perspective to investigate the financial market responses to the IRA.
We study U.S. stock market movements following two key climate policy news events. First, on July 14, 2022, the withdrawal of support for new climate spending by Senator Joe Manchin pushed the probability of any near-term climate policy action to almost zero. Then, on July 27, 2022, the IRA was unveiled, and it became obvious that sizable climate policy legislation would be enacted. The stock market strongly reacted to these two events but in very different ways across industries and firms. In particular, firm-level financial responses to these events differed across measures of greenness such as environmental scores and emission intensities. After the first event, which signaled no climate policy action in the near term, the stock market values of green firms—those with relatively low emission intensities and superior environmental scores—fell, and the values of brown firms rose. By contrast, with the announcement of a near-certain IRA, green firms benefited, and brown firms did not. The heterogeneous stock market responses across these measures of greenness are statistically and economically significant and support the use of such metrics in identifying climate policy exposure.
Our results also contribute to a growing literature on the pricing of climate risks in financial markets. The two events studied represent major realizations of climate policy transition risk. Such transition risks are of keen interest to central banks and other financial supervisory authorities that have started to quantify them through climate scenario analyses. The chief concern is that if investor expectations were to adjust precipitously to new climate policies, the resulting adverse revaluations of carbon-dependent assets could have severe implications for financial solvency and stability. While the financial market response to the IRA was economically significant, it did not lead to instability or financial stress, suggesting that transition risks posed by climate policies as ambitious as the IRA may be manageable.
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Acknowledgements and disclosures
Acknowledgments: The authors thank Christian Kontz, Sanjay Patnaik and David Wessel for helpful comments. The views expressed here are those of the authors and do not necessarily reflect the views of others in the Federal Reserve System.
Disclosures: Michael D. Bauer was funded by Deutsche Forschungsgemeinschaft (German Research Foundation), project no. 509502478. Other than the aforementioned, the authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. The authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article.
The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.
