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Navigating climate policy shocks: optimal monetary policy responses

Author

Listed:
  • Marco Carli

    (Italian Ministry of Economy and Finance and Tor Vergata University)

  • Francesca Diluiso

    (Bank of England)

  • Mathias Hoffmann

    (Deutsche Bundesbank)

Abstract

How should monetary policy respond to climate policy shocks? We develop an Environmental New-Keynesian model with green and fossil energy to assess the macroeconomic impacts of carbon pricing and green subsidy shocks and to identify the optimal monetary policy responses. Our findings indicate that these shocks create a policy trade-off between stabilizing inflation and the output gap. This trade-off is resolved in favor of output-gap stabilization, with optimal monetary policy focusing on dampening real output fluctuations while temporarily looking through inflation movements. Dual mandate Taylor rules yield lower welfare costs than inflation-only targeting rules and align the welfare performances of core and headline inflation targeting regimes.

Suggested Citation

  • Marco Carli & Francesca Diluiso & Mathias Hoffmann, 2026. "Navigating climate policy shocks: optimal monetary policy responses," Bank of England Staff Working Paper series 1211, Bank of England.
    • Handle: RePEc:boe:boeewp:023787
    as

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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2026/navigating-climate-policy-shocks-optimal-monetary-policy-responses.pdf
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    More about this item

    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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