Green Transition in the Euro Area: Domestic and Global Factors

Key Question Being Explored in This Insight:

The green transition requires careful fiscal policy design to balance economic sustainability with climate goals. Kostas Mavromatis explores the macroeconomic effects of carbon taxes, green subsidies, and global policy coordination.

View the page of: Kostas Mavromatis

Institution: De Nederlandsche Bank

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Of all.

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Thank you very much for giving us the opportunity

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to talk about our research.

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Uh, before starting, let me,

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make the usual disclaimer that the,

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the views expressed in this project,

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reflect those solely of the authors

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and not those of the ECB, the Dutch Central Bank, the Bank

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of Slovenia, the Bank of Spain, and the

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and the Bank of Luxembourg.

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The motivation essentially, was,

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triggered by the, the analysis

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of the international dimensions of, of,

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of climate related policies.

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So, the, in the literature there is already, a lot

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of evidence, as regards the, macroeconomic effects

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of climate related policies of carbon taxes, for instance,

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but very,

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little is known about the international dimensions.

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And what I mean by that, essentially

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whenever there is a, a, a climate related policy,

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there are effects on inflation or not, and so on.

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And, and, and then subsequently domestic,

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authorities react to it,

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be it the central bank or the governments.

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And this has important implications

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for international s like, the exchange rates, the terms

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of trade, which then in turn,

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affect the, the domestic economy.

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Our motivation was basically to add to

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what we already know from existing,

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well-established literature by great scholars,

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about the effects of,

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climate policies on inflation output, and,

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and the, and the rest of, of,

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of key macroeconomic, variables.

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So in the literature, there is a well established result,

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for instance, that, carbon taxes, the raise,

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energy inflation.

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And as such, they, the, the, the, the,

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the raise aggregate inflation or CPI inflation, if you like.

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So, and this, and they are,

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and they are contractionary the literary contraction.

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Because of the inflationary pressure,

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the domestic central bank is gonna raise interest rates,

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which all else equal, will likely,

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appreciate the domestic currency.

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Now, the appreciating pressure to the currency will tend

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to lower, import prices.

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And as such, has to,

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and as such will have a, a, a, an effect on,

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on aggregate inflation of the opposite direction,

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compared to that of carbon, of carbon taxes.

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The, the extent to which the, the exchange rate effect

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and the, impact

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and its impact on import prices, will offset or partly

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or fully the, the impact

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of carbon taxes on,

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on inflation depends on the exchange rate pass through.

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Okay? But the key message here is that,

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because of the inflationary impact of carbon taxes,

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for instance, the currency,

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domestic currency appreciates, and this

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Mitigates, the, the inflationary impact

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as a second round effect.

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It's, of course, this, this means that different sectors

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of the economy, are affected differently

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because some sectors are more exposed to exchange rate,

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risk, if you like,

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and others are less exposed to,

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fluctuations in the currency.

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So, so, in a nutshell,

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the, the, the, the, the international dimension,

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the international variables can generate an additional,

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layer of assymetry, if you like, in the effects of,

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of carbon related or climate related policies.

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Now, when it comes to subsidies, as we find in the paper

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and, and as has been found in other,

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papers in the literature, green energy subsidies obviously,

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facilitate transition, okay?

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Because they, they, they, they, they,

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they make the expenditure switching either from the side

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of firms or from the side of, of households,

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towards green energy inputs

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or, consumption goods, faster.

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Okay? So, so this for sure, what we find in,

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in the paper is that carbon taxes alone is, is, is,

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is a good step, but you need

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for sure a green energy subsidies as well.

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Both policies, both carbon, taxes

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or investment, subsidies in subsidies to,

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for green energy investment, both, serve the,

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the same, goal.

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Okay? So this is, to, to, to reduce the emissions,

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switch to green energy, and so on.

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However, we are talking about two,

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two different fiscal instruments, right?

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So, which affect, the economy in a different way,

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at least in the model that, in the way we have modeled it.

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Uh, so carbon taxes affect, both sides of the,

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of the, of the economy in the sense

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that in both the households, for instance, and,

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and firms, the demand on the supply side

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of the economy,

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and they are inflationary, whereas investment subsidies,

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the, the, the, the, the, the initialization

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of the effects starts from the demand side of the economy.

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It's the private sector that invests and,

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and receives subsidies to for green investment,

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which then transmits into the prices of, of,

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of inputs in the green energy sector, for instance.

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So, and, and, and,

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and as such, it is, it has deflationary pressures.

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Of course, more research is, is required there to,

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to make sure that this is a, a well established result.

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This is, this is, this is, this is a first attempt, and,

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and in the paper, we associate investment subsidies

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or in subsidies to, for good investment with taxes on dirty,

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investment, if you like.

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So, so

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because, the share of dirty energy,

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in general in the economy as we calibrated this larger,

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Taxes on, dirty energy, obviously, dump

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and aggregate investment,

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and that's why, there is a,

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a negative demand effect, if you like.

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That leads to, deflationary pressures.

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Um, now the subsidies, the, the,

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the green investment investment subsidies obviously

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mitigate the, the, the, the recession

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because of the dumping of investment and,

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and the deflationary effects.

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Um, so, so, in, again, in a, in a, in a, in a nutshell,

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the carbon taxes and investments have,

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these are different instruments.

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They serve the same, goal,

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but they can have,

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different impacts when it comes to prices.

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When it comes to aggregate output, we find that both,

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can lead to a, a, a contractionary effect on,

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on, on our global coordination is important.

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Uh, of course, when it comes to climate alone, this is

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very important because it, it,

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it reduces emissions globally.

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But when it comes to the macroeconomic effects,

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global coordination, can, alter

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or can amplify or, or,

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or mitigate the effects of the domestic economy of,

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of climate related policies.

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We find, for instance, that, you know, the, the way,

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inflation is impacted in, in an economy compared

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to another economy is important

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because, the, this will,

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imply in different monetary po policy response.

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And if there are small asymmetries triggered in the,

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in the way, monetary policy reacts across countries,

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this has important implications for the exchange rate.

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And, and as such, depending on, again,

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on the exchange rate pass through it, it has, it can amplify

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or, mitigate the effect of, of carbon

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policies in, in, in, in, in,

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in a specific region, for instance.

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And, depending on the direction of the effect

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of the direction of the, change in the,

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in the exchange rate,

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different sectors within eco an

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economy are affected differently.

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So the tradable sector might benefit

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or even might, experience some, some,

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some, some, some, some costs, some additional costs

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because of, lost competitiveness, or

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because of, the fact that they, the, the, the, the, the,

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the, the, the, prices of, of goods,

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internationally, go higher.

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So, in the literature, there are,

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important contributions by great scholars,

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that analyze those effects.

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So, one important result,

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by Diego K for instance, is that the,

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poor poorer households, are gonna suffer more,

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because of, of, of, of, of carbon taxes, simply

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because energy,

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The consumption of energy,

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is the largest share in the consumption basket.

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And, and as such, the, the, the, the, the, the, the,

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the, the impact on their consumption is, is larger.

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And on top of that, let's not forget that you,

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that there is, some sort of consensus that the, the,

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the, carbon tax, for instance, lead to,

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contractionary pressures.

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And as such, they can, put downward pressure on,

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on wages, which for, for, for poor households,

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it is an additional layer of, of, of, of, of negative,

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wealth effects.

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So, so, so, so for sure,

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the share of energy

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and the consumption, bundle of, of, of, of,

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of the household is important

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and will determines of course the extent

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to which a specific household might be affected.

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Uh, when it comes to, to, to firms, as I said,

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earlier, it is,

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and this is what we find also in the paper,

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it is really the, the, the extent to which,

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a specific sector is exposed to international threat.

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So what we find is that following a, a,

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an increasing carbon taxes, all l sql,

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the exchange rate of the domestic economy appreciates,

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which means that the tradable sector not only

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incurs a higher, a higher, higher costs

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because of higher, carbon taxes,

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but at the same time, the, there are costs

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because the additional costs,

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because the, of the depreciation of the cannabis.

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So, so, so, so the global demand for the tradable goods,

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produced domestically goes down,

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and which is a, a layer,

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and when additional cost that non tradable sector,

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the service sector, for instance, is, is not faced with.

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So, so we find,

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and we, we show that the, the, the, the tradables,

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sector, can suffer more in this case.

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So there is, there are symmetric effects both on the

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household side and on the firm side,

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especially on the firm side,

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especially when we bring in the international dimension

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and international implications of carbon tax,

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carbon taxes, for instance, right now, we have,

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as I mentioned earlier, a number

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of papers using DSG models to analyze,

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the microeconomic effects of climate related policies.

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So what we know for sure is that,

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there are tradeoffs, they can imply,

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climate trade policy for, for instance,

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carbon taxes can imply tradeoffs.

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And, of course, the, the, the, the magnitude

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of these tradeoffs,

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and by tradeoffs, I mean like rising inflation, which will,

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cause a, a, a A can be associated with a,

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with a decline in, in, in economic activity,

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of course the, the, the

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Monetary policy response, for instance, due

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to the inflationary pressures can,

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amplify those, those, those three jobs.

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So, this is, this is, something

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that we, we most papers, agree upon.

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Um, what is important is that,

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and I think for the future, it would be to, to, to,

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to have a, a, a study that gathers most

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of these models or as many, of those models

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as we can to, assess, the,

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impact that, is, is, is each model,

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finds, on inflation, on output, output,

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and so on, so that you have a clearer picture about the

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magnitude of the effects.

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Because different models,

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although the di the direction of the effects is the same,

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the qualitative implications are the same.

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The quantitative implications are not necessarily the same.

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And this, and this depends on, on the assumptions

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of the model, on the transmission channels, on, on, on and,

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and on, and, and on a big number of parameters,

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from elasticity of substitution, from, shares

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of energy consumption, bundles from, openness,

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and so and so on.

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So, so I think,

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I think we've learned a lot already from DSG models,

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simply because of the, the feature, all sort of frictions

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that, might,

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enrich our understanding of, of, of,

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of the transmission channels of carbon,

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pricing, for instance.

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Um, but of course, there's still a lot of room, to, to,

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to, to, to, to, to grasp a better idea about the,

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the magnitude of the effects and,

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and the, the, the better understanding of the, the,

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what the most important transmission channels are.

Quick Answers

00:00:00 - Of all. Thank you very much for giving us the opportunity to talk about our research. before starting, let me, make the usual disclaimer that the, the views expressed in this project, reflect those solely of the authors and not those of the ECB, the Dutch Central Bank, the Bank of Slovenia, the Bank of Spain, and the and the Bank of Luxembourg. The motivation essentially, was, triggered by the, the analysis

00:00:33 - of climate related policies. So, the, in the literature there is already, a lot of evidence, as regards the, macroeconomic effects of climate related policies of carbon taxes, for instance, but very, little is known about the international dimensions. And what I mean by that, essentially whenever there is a, a, a climate related policy, there are effects on inflation or not, and so on. And, and, and then subsequently domestic,

00:01:06 - be it the central bank or the governments. And this has important implications for international s like, the exchange rates, the terms of trade, which then in turn, affect the, the domestic economy. Our motivation was basically to add to what we already know from existing, well-established literature by great scholars, about the effects of, climate policies on inflation output, and,

00:01:36 - of key macroeconomic, variables. So in the literature, there is a well established result, for instance, that, carbon taxes, the raise, energy inflation. And as such, they, the, the, the, the, the raise aggregate inflation or CPI inflation, if you like. So, and this, and they are, and they are contractionary the literary contraction. Because of the inflationary pressure, the domestic central bank is gonna raise interest rates,

00:02:11 - appreciate the domestic currency. Now, the appreciating pressure to the currency will tend to lower, import prices. And as such, has to, and as such will have a, a, a, an effect on, on aggregate inflation of the opposite direction, compared to that of carbon, of carbon taxes. The, the extent to which the, the exchange rate effect and the, impact and its impact on import prices, will offset or partly

00:02:45 - of carbon taxes on, on inflation depends on the exchange rate pass through. Okay? But the key message here is that, because of the inflationary impact of carbon taxes, for instance, the currency, domestic currency appreciates, and this Mitigates, the, the inflationary impact as a second round effect. It's, of course, this, this means that different sectors of the economy, are affected differently because some sectors are more exposed to exchange rate,

00:03:15 - and others are less exposed to, fluctuations in the currency. So, so, in a nutshell, the, the, the, the, the international dimension, the international variables can generate an additional, layer of assymetry, if you like, in the effects of, of carbon related or climate related policies. Now, when it comes to subsidies, as we find in the paper and, and as has been found in other,

00:03:47 - facilitate transition, okay? Because they, they, they, they, they, they make the expenditure switching either from the side of firms or from the side of, of households, towards green energy inputs or, consumption goods, faster. Okay? So, so this for sure, what we find in, in the paper is that carbon taxes alone is, is, is,

00:04:16 - for sure a green energy subsidies as well. Both policies, both carbon, taxes or investment, subsidies in subsidies to, for green energy investment, both, serve the, the same, goal. Okay? So this is, to, to, to reduce the emissions, switch to green energy, and so on. However, we are talking about two, two different fiscal instruments, right? So, which affect, the economy in a different way,

00:04:50 - so carbon taxes affect, both sides of the, of the, of the economy in the sense that in both the households, for instance, and, and firms, the demand on the supply side of the economy, and they are inflationary, whereas investment subsidies, the, the, the, the, the, the initialization of the effects starts from the demand side of the economy. It's the private sector that invests and, and receives subsidies to for green investment,

00:05:22 - of inputs in the green energy sector, for instance. So, and, and, and, and as such, it is, it has deflationary pressures. Of course, more research is, is required there to, to make sure that this is a, a well established result. This is, this is, this is, this is a first attempt, and, and in the paper, we associate investment subsidies or in subsidies to, for good investment with taxes on dirty, investment, if you like. So, so because, the share of dirty energy,

00:05:56 - Taxes on, dirty energy, obviously, dump and aggregate investment, and that's why, there is a, a negative demand effect, if you like. That leads to, deflationary pressures. now the subsidies, the, the, the green investment investment subsidies obviously mitigate the, the, the, the recession because of the dumping of investment and, and the deflationary effects. so, so, in, again, in a, in a, in a, in a nutshell,

00:06:29 - these are different instruments. They serve the same, goal, but they can have, different impacts when it comes to prices. When it comes to aggregate output, we find that both, can lead to a, a, a contractionary effect on, on, on our global coordination is important. of course, when it comes to climate alone, this is very important because it, it, it reduces emissions globally. But when it comes to the macroeconomic effects,

00:07:04 - or can amplify or, or, or mitigate the effects of the domestic economy of, of climate related policies. We find, for instance, that, you know, the, the way, inflation is impacted in, in an economy compared to another economy is important because, the, this will, imply in different monetary po policy response. And if there are small asymmetries triggered in the,

00:07:34 - this has important implications for the exchange rate. And, and as such, depending on, again, on the exchange rate pass through it, it has, it can amplify or, mitigate the effect of, of carbon policies in, in, in, in, in, in a specific region, for instance. And, depending on the direction of the effect of the direction of the, change in the, in the exchange rate, different sectors within eco an

00:08:03 - So the tradable sector might benefit or even might, experience some, some, some, some, some, some costs, some additional costs because of, lost competitiveness, or because of, the fact that they, the, the, the, the, the, the, the, the, prices of, of goods, internationally, go higher. So, in the literature, there are, important contributions by great scholars,

00:08:36 - So, one important result, by Diego K for instance, is that the, poor poorer households, are gonna suffer more, because of, of, of, of, of carbon taxes, simply because energy, The consumption of energy, is the largest share in the consumption basket. And, and as such, the, the, the, the, the, the, the, the, the impact on their consumption is, is larger.

00:09:08 - that there is, some sort of consensus that the, the, the, carbon tax, for instance, lead to, contractionary pressures. And as such, they can, put downward pressure on, on wages, which for, for, for poor households, it is an additional layer of, of, of, of, of negative, wealth effects. So, so, so, so for sure,

00:09:37 - and the consumption, bundle of, of, of, of, of the household is important and will determines of course the extent to which a specific household might be affected. when it comes to, to, to firms, as I said, earlier, it is, and this is what we find also in the paper, it is really the, the, the extent to which, a specific sector is exposed to international threat. So what we find is that following a, a, an increasing carbon taxes, all l sql,

00:10:13 - which means that the tradable sector not only incurs a higher, a higher, higher costs because of higher, carbon taxes, but at the same time, the, there are costs because the additional costs, because the, of the depreciation of the cannabis. So, so, so, so the global demand for the tradable goods, produced domestically goes down, and which is a, a layer, and when additional cost that non tradable sector,

00:10:45 - So, so we find, and we, we show that the, the, the, the tradables, sector, can suffer more in this case. So there is, there are symmetric effects both on the household side and on the firm side, especially on the firm side, especially when we bring in the international dimension and international implications of carbon tax, carbon taxes, for instance, right now, we have, as I mentioned earlier, a number

00:11:18 - the microeconomic effects of climate related policies. So what we know for sure is that, there are tradeoffs, they can imply, climate trade policy for, for instance, carbon taxes can imply tradeoffs. And, of course, the, the, the, the magnitude of these tradeoffs, and by tradeoffs, I mean like rising inflation, which will, cause a, a, a A can be associated with a,

00:11:51 - of course the, the, the Monetary policy response, for instance, due to the inflationary pressures can, amplify those, those, those three jobs. So, this is, this is, something that we, we most papers, agree upon. what is important is that, and I think for the future, it would be to, to, to, to have a, a, a study that gathers most

00:12:25 - as we can to, assess, the, impact that, is, is, is each model, finds, on inflation, on output, output, and so on, so that you have a clearer picture about the magnitude of the effects. Because different models, although the di the direction of the effects is the same, the qualitative implications are the same. The quantitative implications are not necessarily the same. And this, and this depends on, on the assumptions

00:12:56 - and on, and, and on a big number of parameters, from elasticity of substitution, from, shares of energy consumption, bundles from, openness, and so and so on. So, so I think, I think we've learned a lot already from DSG models, simply because of the, the feature, all sort of frictions that, might, enrich our understanding of, of, of,

00:13:41 - pricing, for instance. but of course, there's still a lot of room, to, to, to, to, to, to, to grasp a better idea about the, the magnitude of the effects and, and the, the, the better understanding of the, the, what the most important transmission channels are.

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