Research

Abstract: We study how alternative carbon pricing policies, namely carbon taxes and cap-and-trade schemes, affect macroeconomic dynamics and the welfare cost of business cycles in a dynamic stochastic general equilibrium model with financial frictions and pollution externalities. Financial frictions play a critical role in shaping how business cycle shocks propagate under different climate policy regimes. In particular, we find that, in the presence of financial frictions, the welfare costs of business cycles are generally lower under cap-and-trade systems than under carbon taxes. This advantage reflects the automatic stabilizing properties of cap-and-trade: as permit prices adjust procyclically, they help dampen financial amplification effects. The welfare gap between the two policies narrows as credit markets become more efficient or when countercyclical macroprudential regulation is introduced to weaken shock transmission.

Abstract: Agents may be unsure about the productive potential of green technology and of the non-polluting sector due to imprecise information or misguiding news. I study the impact of this deep uncertainty in the context of the transition to a low-carbon economy in a dynamic stochastic general equilibrium model with polluting and green sectors and agents who, due to their ambiguity aversion, take decisions under pessimistic expectations about the future productivity of the latter sector. In the short term, losses of confidence can shift the balance of the economy in favor of investment in the polluting sector and lead to an increase in emissions. Coupling environmental tax and green subsidy can partially counteract this imbalance when the long-run forecast of agents ends up realizing, while also avoiding delays in the green transition. A dynamic version of the policy mix is also able to mitigate the short-term effects of drops in confidence.

Abstract: How should monetary policy respond to climate policy shocks? We develop an Environmental New-Keynesian model to study the macroeconomic effects of carbon pricing and green subsidy shocks and the optimal monetary policy responses. Given the imperfect complementarity between energy and other production inputs or consumption goods, optimal monetary policy should aim to dampen real output fluctuations while ensuring long-term price stability. This implies that the policy rate should be temporarily reduced in response to a carbon price hike and raised in response to a green subsidy increase. Our findings show that dual mandate Taylor rules outperform those targeting only inflation. Additionally, rules focusing on core inflation result in lower welfare costs compared to those targeting headline inflation. However, this difference is reduced in response to a green subsidy shock or when the short-term dependence of the economy on fossil fuels and energy increases.

Abstract: Low confidence in the return from investment in the green sector may hinder sustainable financing and the transition to a low-carbon economy. I study the impact of this deep uncertainty in a dynamic stochastic general equilibrium model featuring both a polluting and a green sector with financially constrained firms and agents who, due to their ambiguity aversion, take decisions under pessimistic expectations about the future productivity of the latter sector. In the short term, losses of confidence can shift the balance of the economy in favor of investment in the polluting sector, leading to an increase in emissions and a reduction in green loans over time. State-contingent policies akin to sector-specific macroprudential rules are able to partially reinstate the balance of the system and mitigate the fall in green financing.