Climate Policies and Business Cycles: The Effects of a Dynamic Cap

This paper compares a static cap-and-trade policy with a dynamically adjusting policy, and concludes that a dynamic cap-and-trade system leads to lower volatility in labour markets and allowance prices. This confirms that the desired stabilisation of permit markets can be achieved through dynamic rules.

Pub. Date
20 November, 2023
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Main Points

  • More and more countries are implementing market-based climate policy instruments to mitigate global warming. These instruments have systemic effects on the macroeconomy, affecting both long-term and short-term dynamics.
  • Based on a New Keynesian DSGE model with several sources of uncertainty and various types of frictions, we compare the economic performance of constant and dynamic policy rules. According to the results of our numerical simulations, a constant cap and trade system is associated with lower volatility in output, consumption, investment and emissions.