Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/301153 
Year of Publication: 
2024
Series/Report no.: 
IWH Discussion Papers No. 18/2024
Publisher: 
Halle Institute for Economic Research (IWH), Halle (Saale)
Abstract: 
In this paper, we discuss how environmental damage and emission reduction policies affect the conduct of monetary policy in a two-sector (clean and dirty) dynamic stochastic general equilibrium model. In particular, we examine the optimal response of the interest rate to changes in sectoral inflation due to standard supply shocks, conditional on a given environmental policy. We then compare the performance of a nonstandard monetary rule with sectoral inflation targets to that of a standard Taylor rule. Our main results are as follows: first, the optimal monetary policy is affected by the existence of environmental policy (carbon taxation), as this introduces a distortion in the relative price level between the clean and dirty sectors. Second, compared with a standard Taylor rule targeting aggregate inflation, a monetary policy rule with asymmetric responses to sector-specific inflation allows for reduced volatility in the inflation gap, output gap, and emissions. Third, a nonstandard monetary policy rule allows for a higher level of welfare, so the two goals of welfare maximization and emission minimization can be aligned.
Subjects: 
climate change
environmental policy
inflation
macroeconomic stabilization
monetary policy
JEL: 
E32
E52
E58
Q54
Q58
Document Type: 
Working Paper

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