Conference Agenda

We build a Climate-economy IAM incorporating a monopolistically competitive supply side (Krugman, 1980) resulting in a model featuring increasing returns to scale. Optimal policy is both a carbon tax to shift composition towards low carbon sectors, and an investment subsidy to boost the size of the capital stock. Our main theoretical result is that the optimal carbon tax is decreasing in the the degree of increasing returns to scale in the economy. We use this model to look at Chinese overcapacity in manufactures, explaining the combination of cheap finance enabled investments in the capacity to create vast scale in EV and solar panel manufactures.

The optimal transition to a low-carbon economy must account for adjustment costs in switching from dirty to clean capital, technological progress, and economic and climatic shocks. We study the low-carbon transition using a dynamic stochastic general equilibrium model with emissions abatement costs calibrated on a large energy modelling database, solved with recursive methods. We show how capital inertia puts upward pressure on emissions and temperatures in the short run, but that nonetheless it is optimal to actively disinvest from -- to `strand' -- a significant share of the dirty capital stock. Conversely, clean technological progress, as well as uncertainty about climatic and economic factors, lead to lower emissions and temperatures in the long run. Putting these factors together, we estimate a net premium of 33% on the optimal carbon price today relative to a `straw man' model with perfect capital mobility, fixed abatement costs and no uncertainty.

We study how climate policy volatility shapes expectations about the low-carbon transition. We run a learning-to-forecast experiment in which participants repeatedly predict the future carbon tax at short, medium, and long horizons. These forecasts feed a parsimonious transition model with imperfect policy commitment, mapping beliefs into clean investment, perceived transition risk, and the implemented policy path. Treatments introduce probabilistic shocks to government climate commitment, mimicking different degrees of political polarisation. To isolate expectation-driven effects, we compare experimental outcomes to a fully informed rational-expectations (FIRE) benchmark. Three results stand out. First, participants underweight policy risk ex ante. Second, commitment shocks trigger systematic overreaction -- stronger and more persistent under high instability -- with forecast dispersion spiking on impact and then gradually declining. Third, early adverse shocks generate large temporary shortfalls in clean investment and leave persistent drags on the pace of decarbonisation. Overall, the results highlight credibility and timing as first-order determinants of effective climate policy.

The financial stability risks associated with decarbonization are a growing concern for policymakers and financial institutions. This paper studies the macroeconomic consequences of transition risk in an environmental dynamic stochastic general equilibrium model with a frictional financial sector. We analyze three sources of transition risk: one policy-driven source of transition risk arising from an increase in carbon tax, and two preference-based sources: a shock to consumer preferences and a shock to investor preferences. For a given emissions reduction target, preference shocks generate larger macroeconomic and financial instability than a carbon tax while delaying environmental benefits. We further show that a tax-and-subsidy scheme on banks’ asset holdings mitigates these adverse effects and brings the economy closer to a first-best scenario, where environmental externalities and financial frictions are absent. Overall, carbon pricing and targeted financial sector policies play a central role in mitigating transition risks, ensuring a more stable adjustment path and leading to a long-run equilibrium with fewer distortions.