Economic models used by governments, central banks and investors are “increasingly understating” climate change risks as the world continues to heat up.
A new report led by the University of Exeter’s Green Futures Solutions team, in partnership with financial think-tank Carbon Tracker, warns that today’s flawed damage models are creating a “false sense of security” for the global economy.
It calls for closer collaboration between climate scientists, economists, regulators and investors before temperatures rise to 2°C above pre-industrial levels. This is the threshold scientists believe would trigger several catastrophic tipping points such as mass biodiversity loss and ocean acidification.
“Current economic models systematically underestimate climate damages because they can’t capture what matters most – the cascading failures, threshold effects, and compounding shocks that define climate risk in a warmer world and could undermine the very foundations of economic growth,” says lead author Dr Jesse Abrams.
Financial projections ignore extreme weather
Economic modelling has traditionally linked damages to changes in global mean temperatures, ignoring the impact of climate-fuelled extreme weather such as heatwaves, floods and drought.
Last summer, extreme weather in Europe sparked short-term economic losses of at least €43 billion, with total costs slated to hit a whopping €126 billion by 2029.
A study published in September 2025, led by Dr Sehrish Usman at the University of Mannheim in collaboration with European Central Bank (ECB) economists, found that heatwaves, droughts and floods affected a quarter of all EU regions during this period.
The immediate losses amount to 0.26 per cent of the EU’s economic output in 2024, but the study’s authors stress that these estimates are likely conservative as they don’t include compound impacts when extreme events occur simultaneously, such as heatwaves and droughts.
They also don’t include the cost of hazards like wildfires, which broke records across Europe last year, or hail and wind damage from storms.
In parts of South and Southeast Asia, monsoon flooding triggered economic losses of 500 billion baht (around €133 billion) in Thailand alone.
Scientists warned the overlapping of tropical storms in the area was likely fuelled by climate damage – with widespread devastation worsened by deforestation.
‘Climate damages are not marginal’
A central finding of the report is that most existing economic frameworks implicitly treat climate change as a “marginal shock” to an otherwise stable economic system.
Researchers argue that this assumption “no longer holds” as climate change continues to increasingly disrupt multiple sectors at once.
“Rather than simply reducing output, climate change is likely to reshape economic structures themselves – altering where people live, what can be produced, how infrastructure functions, and which regions remain economically viable,” the report states.
“This distinction is critical for policymakers and financial institutions: risks that alter system structure cannot be assessed using models designed for small, reversible shocks.”
Incidents like extreme weather can also have compounded effects, which are often overlooked. For example, when one area faces climate shocks, they can cause ripple effects across food systems, supply chains and global markets – yet many models treat climate damages as an “isolated event”.
“Instead, risks accumulate, reinforce one another, and can push systems toward instability,” the report warns.
The issue with GDP
A common misconception about climate-related GDP damage figures is that a projected 20 per cent loss, for example, represents a direct reduction of today’s economic output.
However, the report argues that economists have created a “magical economy” whereby three per cent annual GDP growth continues indefinitely into the future, regardless of the severity of climate impacts.
“Only then, is the 20 per cent subtracted from that growth-enlarged total pie, of a fictional future with or without climate change,” the report states.
“At no point do economists’ models factor in the possibility of the economy structurally declining in size.”
One of the major issues researchers found is that GDP is too “narrow” to represent climate damages, with estimates significantly underpresenting true economic, societal and environmental harm.
This is because GDP does not take into consideration factors such as human mortality, inequality, cultural loss and displacement, ecosystem degradation, and disruption to social life.
“In some cases, GDP may even rise following disasters due to reconstructions pending, masking welfare losses entirely,” the report adds.
“As a result, GDP-centred assessments can give policymakers and financial institutions a false sense of resilience, even as underlying vulnerability increases.”
The report joins the growing calls to complement GDP with metrics that better reflect lived economic reality and long-term stability.