Pollution and Labor Market Search Externalities Over the Business Cycle
We study the relationship between unemployment, environmental policy, and business cycles. We develop a dynamic stochastic general equilibrium real business cycle model that includes both a pollution externality and congestion externalities from labor market search frictions, which generate unemployment. We consider two policies to address the market failures: an emissions tax and a tax or subsidy on job creation. With both policies present, the efficient outcome can be achieved. When one policy is constrained or absent, we solve for the second best. The absence of a vacancy policy to address the congestion externalities substantially affects the value of the emissions tax, both in steady state and over the business cycle.
Thanks to Yin Germaschewski, Marc Hafstead, Jay Harvoth, Milton Marquis, and seminar participants at the ASSA, Econometric Society, AERE, Midwest Macro, and SEA conferences for comments, and to Ken Castellanos and Wenwen Li for valuable research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.