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Climate change and monetary policy: a Bayesian DSGE perspective

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  • Juha Tervala

    (University of Helsinki)

  • Timothy Watson

    (Department of Social Services)

Abstract

This study utilizes a Bayesian DSGE model, which includes a mechanism for endogenous productivity, calibrated with Australian data, to assess the impact of monetary policy on CO2 emissions. A 1% cyclical deviation in GDP is associated with a 0.5% change in emission flows relative to the trend. A 1 percentage point increase in interest rates results in a 0.8% decrease in GDP relative to its trend, along with a 0.4% decline in emission flows and a 2.1% reduction in pollution stock, both relative to their trends. Our study finds that the short-term impact of a monetary policy shock on emissions exceeds previous estimates. Historical decomposition reveals that while monetary policy shocks contribute to cyclical fluctuations in emissions, expansionary (contractionary) monetary policy often coincides with negative (positive) private demand shocks, which reduce (increase) emissions. Given the long-term nature of climate change and the countercyclical role of monetary policy in emissions variability, environmental concerns should not be a central focus of monetary policy.

Suggested Citation

  • Juha Tervala & Timothy Watson, 2025. "Climate change and monetary policy: a Bayesian DSGE perspective," Empirical Economics, Springer, vol. 69(2), pages 715-734, August.
    • Handle: RePEc:spr:empeco:v:69:y:2025:i:2:d:10.1007_s00181-025-02747-8
    DOI: 10.1007/s00181-025-02747-8
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    References listed on IDEAS

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    1. Tervala, Juha & Watson, Timothy, 2022. "Hysteresis and fiscal stimulus in a recession," Journal of International Money and Finance, Elsevier, vol. 124(C).
    2. Khan, Hashmat & Metaxoglou, Konstantinos & Knittel, Christopher R. & Papineau, Maya, 2019. "Carbon emissions and business cycles," Journal of Macroeconomics, Elsevier, vol. 60(C), pages 1-19.
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    Keywords

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • Q50 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - General

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