Environmental performance, financial development, systemic risk and economic uncertainty: What are the linkages?

Abstract

The paper studies the relationships among the composite indicators of environmental performance, financial development, systemic risk and economic uncertainty for a balanced panel of 57 countries during 2010–2020. The analysis builds on panel local projections by Jordá (2005). In addition to the whole panel, this technique also applies to two sub-panels obtained via the K-means clusterization conditional on a set of composite indicators of environmental performance. We underscore a two-way relationship between systemic risk and environmental performance. An increase in systemic risk improves the environmental quality, albeit to the detriment of economic growth and energy consumption, whereas ex ante higher values of the key composite indicators of environmental performance mitigate systemic risk. Financial development adversely affects environmental performance. Contrary to the prevailing view, this effect is mostly related to the development of financial markets compared to the development of financial institutions. Economic uncertainty is found totally unrelated to the composite indicators of environmental performance. The aforementioned key findings generally hold after splitting the whole panel into the two sub-panels. Overall, our results induce policymakers to treat with caution certain policy recommendations aimed at improving environmental quality, since reducing systemic risk, increasing financial development as a whole or shifting towards a market-based financial system do not necessarily help accomplish this goal.