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

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.