No country is an island. International cooperation and climate change

We explore the cross-country implications of climate-related mitigation policies. Specifically, we set up and estimate a three-country, two-sector (brown vs green) DSGE model with negative production externalities stemming from carbon-dioxide emissions. The model is used to characterize the welfare-enhancing equilibrium under alternative containment policies. According to the optimal policy mix: i) fiscal policy focuses on reducing emissions; ii) countries cooperate with each other to reduce the losses generated by climate policies; iii) monetary policy looks through environmental objectives but adapts its strategy when the costs of the environmental transition materialize. All other policy combinations either fall short of the Paris agreement's objective or are not incentive-compatible, i.e. the implied short-term losses would prevent the implementation of efficient long-term climate policies.