Working Paper

Climate Policy Transition Risk and the Macroeconomy

Abstract: Uncertainty surrounding if the U.S. will implement a federal climate policy introduces risk into the decision to invest in long-lived capital assets, particularly those designed to use, or to replace fossil fuel. We develop a dynamic, general equilibrium model to quantify the macroeconomic impacts of this climate policy transition risk. The model incorporates beliefs over the likelihood that the government adopts a climate policy causing the economy to dynamically transition to a lower carbon steady state. We find that climate policy transition risk decreases carbon emissions today by causing investment to become relatively cleaner and output to fall. This result counters the Green Paradox, which argues that climate policy risk raises emissions today by increasing incentives to extract fossil fuel, expanding its supply. Even allowing for the supply-side response, we find the demand-side response dominates, and the net effect of climate policy transition risk is still to reduce emissions today.

Keywords: climate policy; transition risk; carbon emissions;

https://doi.org/10.24148/wp2021-06

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2022-06-20

Number: 2021-06

Note: The first version of this paper was published February 16, 2021, as "The Macro Effects of Climate Policy Uncertainty."

Related Works

• https://www.frbsf.org/economic-research/publications/working-papers/2021/06/