Green Transition in the euro area: Domestic and global factors

We analyze the economic impact of the green transition in the euro area by extending the Euro Area and Global Economy (EAGLE) model to include green and brown energy sectors. In this model, energy goods are consumed both as final goods by households and as inputs by intermediate goods firms. A carbon tax acts as a cost-push shock, creating stagflation ary effects, particularly when fiscal interventions are not primary-balance neutral. Without subsidies for green energy firms, the green transition is limited to a shift in household ex penditure towards green energy goods. However, when authorities provide subsidies to green energy firms, intermediate goods firms also increase their demand for green energy inputs, thereby strengthening the demand channel in the green energy market and driving its price upward. When carbon taxes are raised globally and governments redistribute carbon tax revenues to green energy firms, the recession in the euro area deepens, and inflationary pres sures increase, partly due to a weakening euro. Taxes on brown capital investment are also contractionary but lead to lower inflation. In this scenario, subsidies for investment in green energy capital can help mitigate the recession. However, overall, taxes on brown capital investment are less effective in driving the green transition compared to carbon taxes. Classification-JEL: C53, E32, E52, F45, H30, Q48