There is increased willingness to address climate change challenges and central banks (among other institutions) are playing a growing role in mitigation strategies. However, tackling climate change requires innovating classic research paths, as they tend to favour the use of models that capture only one of the following: environmental variables, macroeconomic behaviour, or monetary and financial policy.

Policy recommendations based on such models that aim to mitigate the impacts of greenhouse gases should be able to capture macroeconomic variations, monetary and financial policy, as well as environmental constraints, as these are tightly linked. In addition, policymakers are more than ever in need of models that capture the most complete image of the economy in order to take the best course of action.

The authors of this paper assess the effectiveness and interactions of different policies – fiscal, monetary, and macroprudential, each of which is aimed at reducing CO2 emissions – using a macro-financial framework. They show that while a substantial carbon tax is needed in the Euro Area to be aligned with the Paris Agreement, it is likely not enough to meet the additional efforts needed to mitigate climate change. Macroprudential and monetary policies are shown to be necessary, complementary policy tools and could play a major role in climate change mitigation.

This research aims to provide central banks and similar institutions with the tools to contribute to climate change mitigation and demonstrates the importance of including these institutions in the push to reduce global emission levels.

Key points for decision-makers

  •  The authors develop a macro-financial-environmental Dynamic Stochastic General Equilibrium (DSGE) model to make their assessment.
  • They find that the efficiency of an environmental tax on emission reduction heavily depends on the abatement technology used (i.e. there needs to be a low transition cost).
  • The optimal tax policy from a welfare perspective is found to be of a small magnitude, suggesting that a tax policy is not enough for a climate change mitigation strategy.
  • Monetary and macroprudential policies could therefore play a major role in offsetting climate change.
  • In particular, the authors find that a macroprudential policy favourable to the green sector boosts green capital and output, meaning that there is a lower emissions-to-output ratio.
  • With respect to quantitative easing (QE), they find that a carbon tax improves the benefits of both green and dirty asset purchases. They also find that a macroprudential policy is needed to provide an incentive to central banks to engage in green QE, meaning that the choice between dirty and green QE implies a trade-off between higher output and lower emissions.
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