The Macro Effects of Climate Policy Uncertainty

Abstract

Uncertainty surrounding if and when the U.S. government will implement a federal climate policy introduces risk into the decision to invest in capital used in conjunction with fossil fuels. To quantify the macroeconomic impacts of this climate policy risk, we develop a dynamic, general equilibrium model that incorporates beliefs about future climate policy. We find that climate policy risk reduces carbon emissions by causing the capital stock to shrink and become relatively cleaner. Our results reveal, however, that a carbon tax could achieve the same reduction in emissions at less than half the cost.

Uncertainty before and during COVID‐19: A survey

“…Turning to policy, Fried et al. ( 2021 ) investigate the consequences of having uncertainty surrounding the imposition of a carbon tax in the future. They do so by developing a model characterized by agents investing in long‐lived, sector‐specific assets (coal power plants, wind farms).…”

“…Controlling for the level of the temperature, an increase of one degree (Celsius) of the latter's volatility is found to be responsible of an average drop in real GDP growth of 0.9%, and an increase in the volatility of real GDP growth of 1.3% . Turning to policy, Fried et al (2021) investigate the consequences of having uncertainty surrounding the imposition of a carbon tax in the future. They do so by developing a model characterized by agents investing in long-lived, sector-specific assets (coal power plants, wind farms).…”

Climate‐related risks in financial assets

“…Additionally, new information on a firm's exposure to climate‐related risks can lead to reassessments of the risk premium asked by investors. The fundamental uncertainty over the course of climate‐related impacts, both over physical climate change (Deser et al., 2012; Shepherd, 2014) and the policy response (Fried et al., 2019), could manifest as a higher risk premium. ‘Endogenous’ reassessments by investors can change their perception of a firm's exposure to climate‐related risks. For example, a change in the model used for forecasting revenues could lead to a reassessment of the firm's value and thus of the value of its assets.…”

Macrofinancial Risks of the Transition to a Low-Carbon Economy

“…For example, a policy might affect investment behavior and asset prices well before it is implemented or even announced, simply because forward-looking agents might already be considering the possibility of its implementation. Thus far, only a few small-scale general equilibrium models have explicitly examined how uncertainty about the timing of policy or technological breakthroughs might affect macrofinancial and transition dynamics (e.g., Barnett 2019;van der Ploeg and Rezai 2020a;Fried, Novan, and Peterman 2021).…”