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 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. Macroprudential policy alone, without a carbon tax, is not very effective at addressing the pollution externality.
All authors acknowledge support from the Alliance for Market Solutions. Carattini acknowledges support from the Grantham Foundation for the Protection of the Environment through the Grantham Research Institute on Climate Change and the Environment and from the ESRC Centre for Climate Change Economics and Policy as well as from the Swiss National Science Foundation, grant number PZ00P1 180006/1. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.