Climate policy, financial frictions, and transition risk

We study climate and macroprudential policies in an economy with financial frictions. Using a dynamic stochastic general equilibrium model featuring both a pollution market failure and a market failure in the financial sector, we explore transition risk – whether ambitious climate policy can lead to...

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Bibliographic Details
Published in:Review of economic dynamics 2023-12, Vol.51, p.778-794
Main Authors: Carattini, Stefano, Heutel, Garth, Melkadze, Givi
Format: Article
Language:English
Subjects:
Business cycles
Carbon taxes
Financial frictions
Macroprudential policy
Stranded assets
Transition risk
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Summary:We study climate and macroprudential policies in an economy with financial frictions. Using a dynamic stochastic general equilibrium model featuring both a pollution market failure and a market failure in the financial sector, we explore transition risk – whether ambitious climate policy can lead to macroeconomic instability. It can, but the risk can be alleviated through macroprudential policies – taxes or subsidies on banks' assets. Then, we explore efficient climate and macroprudential policy in the long run and over business cycles. The presence of financial frictions affects the steady-state value and dynamic properties of the efficient carbon tax.
ISSN:1094-2025
1096-6099
DOI:10.1016/j.red.2023.08.003