Climate Actions, Market Beliefs, and Monetary Policy

43 Pages Posted: 2 Aug 2021 Last revised: 7 Mar 2022

See all articles by Barbara Annicchiarico

Barbara Annicchiarico

University of Rome, Tor Vergata - Department of Economics and Finance; University of Rome Tor Vergata - Centre for International Studies on Economic Growth (CEIS)

Fabio Di Dio

IGDORE - Institute for Globally Distributed Open Research and Education

Francesca Diluiso

Mercator Research Institute on Global Commons and Climate Change (MCC)

Multiple version iconThere are 2 versions of this paper

Date Written: March 03, 2022

Abstract

This paper studies the role of expectations and monetary policy on the response of the economy to climate actions. We show that in a stochastic environment and without the standard assumption of perfect rationality of agents, there is more uncertainty regarding the path and the economic impact of a climate policy, with a potential threat to the ability of central banks to maintain price stability. Market beliefs and behavioral agents increase the trade-offs inherent to the chosen mitigation tool, with a carbon tax entailing more emissions uncertainty than in a rational expectations model and a cap-and-trade scheme implying a more pronounced pressure on allowances prices and inflation. The impact on price stability is worsened by delays in the implementation of stringent climate policies, by the lack of confidence in the ability of central banks to keep inflation under control, and by the adoption of monetary rules tied to expectations rather than current macroeconomic conditions. Central banks can implement successful stabilization policies that reduce the uncertainty surrounding the impact of climate actions and support the greening process while staying within their mandate.

Keywords: Climate policy; monetary policy; expectations; inflation; market sentiments; business cycle

JEL Classification: D83, Q50, E32, E71

Suggested Citation

Annicchiarico, Barbara and Di Dio, Fabio and Diluiso, Francesca, Climate Actions, Market Beliefs, and Monetary Policy (March 03, 2022). Available at SSRN: https://ssrn.com/abstract=3895754 or http://dx.doi.org/10.2139/ssrn.3895754

Barbara Annicchiarico (Contact Author)

University of Rome, Tor Vergata - Department of Economics and Finance ( email )

Rome, I-00133
Italy

University of Rome Tor Vergata - Centre for International Studies on Economic Growth (CEIS) ( email )

Via Columbia, 2
Rome, I-00133
Italy

Fabio Di Dio

IGDORE - Institute for Globally Distributed Open Research and Education ( email )

Francesca Diluiso

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

Torgauer Straβe 12-15
Berlin, DE 10829
Germany

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