Climate Actions, Market Beliefs and Monetary Policy

46 Pages Posted: 25 Mar 2022

See all articles by Barbara Annicchiarico

Barbara Annicchiarico

Roma Tre University - Department of Law

Fabio Di Dio

IGDORE - Institute for Globally Distributed Open Research and Education

Francesca Diluiso

Bank of England

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Date Written: March 25, 2022

Abstract

This paper studies the role of expectations and monetary policy on the economy’s response 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 25, 2022). CEIS Working Paper No. 535, Available at SSRN: https://ssrn.com/abstract=4066585 or http://dx.doi.org/10.2139/ssrn.4066585

Barbara Annicchiarico (Contact Author)

Roma Tre University - Department of Law ( email )

Via Ostiense 163
Roma, RM 00154
Italy

Fabio Di Dio

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

Francesca Diluiso

Bank of England ( email )

Threadneedle St
London, EC2R 8AH
United Kingdom

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