Effects of linking national carbon markets on international macroeconomics: An open-economy E-DSGE model

Abstract

Linking carbon markets in different economies has become an important form of international climate cooperation. However, the complex socioeconomic effects of linking carbon markets need to be fully assessed. This article develops an open-economy environmental dynamic stochastic general equilibrium (E-DSGE) model that incorporates international trade, asymmetric economies, and heterogeneous production sectors. Based on the example of the linkage between EU and China carbon markets, we analyze the international macroeconomic effects of linking standalone national carbon markets. The main findings are as follows: 1) The linked carbon market improved total social welfare of China and the EU, but led to an uneven distribution of social welfare across regions. 2) China and the EU had better economic performances under a linked carbon market than under two separate carbon markets; moreover, the linked carbon market amplified expansionary effects and mitigated negative cross-border spillover effects. 3) Both separate and linked carbon markets functioned as automatic stabilizers of the economy; the linked carbon markets reduced economic fluctuations in the face of supply-side shocks, while the separate carbon markets reduced economic fluctuations in the face of demand-side shocks.