Climate policy transition risk and the macroeconomy

Stephie Fried, Kevin Novan, William B. Peterman

Research output: Contribution to journalArticlepeer-review

Abstract

Uncertainty surrounding if the U.S. will implement a federal climate policy introduces risk into the decision to invest in long-lived capital assets, particularly those designed to use, or to replace fossil fuel. We develop a dynamic, general equilibrium model to quantify the macroeconomic impacts of this climate policy transition risk. The model incorporates beliefs over the likelihood that the government adopts a climate policy causing the economy to dynamically transition to a lower carbon steady state. We find that climate policy transition risk decreases carbon emissions today by causing investment to become relatively cleaner and output to fall. This result counters the Green Paradox, which argues that climate policy risk raises emissions today by increasing incentives to extract fossil fuel, expanding its supply. Even allowing for the supply-side response, we find the demand-side response dominates, and the net effect of climate policy transition risk is still to reduce emissions today.

Original languageEnglish (US)
Article number104174
JournalEuropean Economic Review
Volume147
DOIs
StatePublished - Aug 2022
Externally publishedYes

Keywords

  • Carbon tax
  • Climate change
  • Environmental macro

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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