Climate change and monetary policy: a Bayesian DSGE perspective

Abstract This study utilizes a Bayesian DSGE model, which includes a mechanism for endogenous productivity, calibrated with Australian data, to assess the impact of monetary policy on CO2 emissions. A 1% cyclical deviation in GDP is associated with a 0.5% change in emission flows relative to the trend. A 1 percentage point increase in interest rates results in a 0.8% decrease in GDP relative to its trend, along with a 0.4% decline in emission flows and a 2.1% reduction in pollution stock, both relative to their trends. Our study finds that the short-term impact of a monetary policy shock on emissions exceeds previous estimates. Historical decomposition reveals that while monetary policy shocks contribute to cyclical fluctuations in emissions, expansionary (contractionary) monetary policy often coincides with negative (positive) private demand shocks, which reduce (increase) emissions. Given the long-term nature of climate change and the countercyclical role of monetary policy in emissions variability, environmental concerns should not be a central focus of monetary policy.