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Climate Policies, Macroprudential Regulation, and the Welfare Cost of Business Cycles

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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.

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  • Barbara Annicchiarico & Marco Carli & Francesca Diluiso, 2022. "Climate Policies, Macroprudential Regulation, and the Welfare Cost of Business Cycles," CEIS Research Paper 543, Tor Vergata University, CEIS, revised 31 Oct 2022.
    • Handle: RePEc:rtv:ceisrp:543
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    More about this item

    Keywords

    Business Cycle; Cap-and-Trade; Carbon Tax; E-DSGE;
    All these keywords.

    JEL classification:

    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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