Working Paper: CEPR ID: DP18308
Authors: Anton Nakov; Carlos Thomas
Abstract: We study the implications of climate change and the associated mitigation measures for optimal monetary policy in a canonical New Keynesian model with climate externalities. Provided they are set at their socially optimal level, carbon taxes pose no trade-offs for monetary policy: it is both feasible and optimal to fully stabilize inflation and the welfare-relevant output gap. More realistically, if carbon taxes are initially suboptimal, trade-offs arise between core and climate goals. These trade-offs however are resolved overwhelmingly in favor of price stability, even in scenarios of decades-long transition to optimal carbon taxation. This reflects the untargeted, inefficient nature of (conventional) monetary policy as a climate instrument. In a model extension with financial frictions and central bank purchases of corporate bonds, we show that green tilting of purchases is optimal and accelerates the green transition. However, its effect on CO2 emissions and global temperatures is limited by the small size of eligible bonds' spreads.
Keywords: Climate Change; Monetary Policy; Carbon Taxation; Green QE
JEL Codes: E31; E32; Q54; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal carbon taxation (H21) | No tradeoffs for monetary policy (E49) |
| Suboptimal carbon taxation (H21) | Tradeoffs between monetary policy goals and climate goals (E63) |
| Tradeoffs between monetary policy goals and climate goals (E63) | Favor price stability (E64) |
| Green tilting of central bank purchases (E52) | Accelerate green transition (Q48) |
| Green tilting of central bank purchases (E52) | Limited impact on CO2 emissions and global temperatures (F69) |
| Optimal monetary policy (E63) | Minimal deviations from strict inflation targeting (E61) |