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Climate Policy and the Long-Run Interest Rate: Insights from a Simple Growth Model

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Abstract

We study the impact of climate policy on the long-run real interest rate in a tractable climate-economy model based on the work of Golosov et al. (2014). When the growth rate of the carbon tax exceeds the growth rate of the price of at least one type of fossil energy, the tax reduces the long-run growth rates of consumption and investment, pushing the interest rate up. We find that if fossil energy prices are constant, a carbon tax that grows at 3.5 percent per year decreases the long-run interest by over 50 basis points. This carbon tax growth rate achieves net zero emissions at the lowest possible cost.

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  • Gregory Casey & Stephie Fried & William B. Peterman, 2024. "Climate Policy and the Long-Run Interest Rate: Insights from a Simple Growth Model," Working Paper Series 2024-37, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:99300
    DOI: 10.24148/wp2024-37
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    1. John Hassler & Per Krusell & Conny Olovsson, 2021. "Directed Technical Change as a Response to Natural Resource Scarcity," Journal of Political Economy, University of Chicago Press, vol. 129(11), pages 3039-3072.
    2. Christoph Hambel & Holger Kraft & Frederick van der Ploeg, 2024. "Asset Diversification Versus Climate Action," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 65(3), pages 1323-1355, August.
    3. Chris Papageorgiou & Marianne Saam & Patrick Schulte, 2017. "Substitution between Clean and Dirty Energy Inputs: A Macroeconomic Perspective," The Review of Economics and Statistics, MIT Press, vol. 99(2), pages 281-290, May.
    4. Mongelli, Francesco Paolo & Pointner, Wolfgang & van den End, Jan Willem, 2022. "The effects of climate change on the natural rate of interest: a critical survey," Working Paper Series 2744, European Central Bank.
    5. Tobias S. Schmidt & Bjarne Steffen & Florian Egli & Michael Pahle & Oliver Tietjen & Ottmar Edenhofer, 2019. "Adverse effects of rising interest rates on sustainable energy transitions," Nature Sustainability, Nature, vol. 2(9), pages 879-885, September.
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    More about this item

    Keywords

    climate policy; R-star;

    JEL classification:

    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • O44 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Environment and Growth
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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