Macroeconomic impact of environmental policy uncertainty and monetary policy implications

Abstract

This paper evaluates the macroeconomic implications of uncertainty arising from delays or unpredictability regarding the timing and extent of environmental policy implementation. An environmental dynamic stochastic general equilibrium (E-DSGE) model shows that increasing uncertainty about environmental policies is associated with a subsequent decline in investment, as firms prefer to postpone investment decisions. The decline in physical investment within polluting sectors subsequently induces a fall in employment, consumption and output. Using a novel climate policy uncertainty index developed by Gavriilidis (2021), alongside Google Trend data index, the paper shows that uncertainty about climate regulations has both recessionary and inflationary effects, corroborating the theoretical findings. Further analysis suggests that appropriate monetary policy tools could moderate the welfare cost arising from the environmental policy uncertainty, emphasizing the need for Central Banks to adopt a more aggressive stance in stabilizing GDP and inflation in the face of environmental policy uncertainty shocks.