  This paper outlines a critical gap in the assessment methodology used to
estimate the macroeconomic costs and benefits of climate policy. It shows that
the vast majority of models used for assessing climate policy use assumptions
about the financial system that sit at odds with the observed reality. In
particular, the models' assumptions lead to `crowding out' of capital, which
cause them to show negative impacts from climate policy in virtually all cases.
We compare this approach with that of the E3ME model, which follows
non-equilibrium economic theory and adopts a more empirical approach. While the
non-equilibrium model also has limitations, its treatment of the financial
system is more consistent with reality and it shows that green investment need
not crowd out investment in other parts of the economy -- and may therefore
offer an economic stimulus.
  The implication of this finding is that standard CGE models consistently
over-estimate the costs of climate policy in terms of GDP and welfare,
potentially by a substantial amount. These findings overly restrict the range
of possible emission pathways accessible using climate policy from the
viewpoint of the decision-maker, and may also lead to misleading information
used for policy making. Improvements in both modelling approaches should be
sought with some urgency -- both to provide a better assessment of potential
climate policy and to improve understanding of the dynamics of the global
financial system more generally.
