Climate Policies, Macroprudential Regulation, and the Welfare Cost of Business Cycles (with B. Annicchiarico and F. Diluiso) [Bank Underground]
R&R, Journal of Money, Credit and Banking
Abstract: We study the performance of alternative climate policies in a dynamic stochastic general equilibrium model that includes an environmental externality and agency problems associated with financial intermediation. Heterogeneous polluting producers finance their capital acquisition by combining their resources with loans from banks, are subject to environmental regulation, are hit by idiosyncratic shocks, and can default. The welfare analysis suggests that a cap-and-trade system will entail substantially lower costs of the business cycle than a carbon tax if financial frictions are stringent, firm leverage is high, and agents are sufficiently risk-averse. Simple macroprudential policy rules can go a long way in reining in business cycle fluctuations, aligning the performance of price and quantity pollution policies, and reducing the uncertainty inherent to the chosen climate policy tool.
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.
Green Financing and Ambiguity [Codes]
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.
Navigating Climate Policy Shocks: Optimal Monetary Policy Responses (with F. Diluiso and M. Hoffmann)
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.