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Environmental policy and convexity of climate change damage functions: an experiment with New Keynesian DSGE model

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  • Samuel Kwesi Dunyo

    (National Institute of Development Administration-NIDA)

Abstract

The paper seeks out to investigate how varying degree of convexity of climate change damage function affect economic output and the dynamic response of macroeconomic variables to shocks under different environmental policy regimes. In an economy featuring nominal rigidities and monopolistically competitive firms together with climate change mitigation policy and firm abatement effort, the results show that the choice of damage function affects long-term growth of the economy and the performance of climate mitigation policy. A highly convex climate damage function has a significant contractionary effect on economic output and by extension consumption and private investment. This result stands irrespective of the environmental policy put in place. The impact of exogenous shocks on the macroeconomic variables is higher than the degree of convexity of the damage function. Cap-and-trade policy compresses the response of macroeconomic variables to these shocks, irrespective of curvature of the damage function. The results are robust to different calibrations of the climate damage functions.

Suggested Citation

  • Samuel Kwesi Dunyo, 2022. "Environmental policy and convexity of climate change damage functions: an experiment with New Keynesian DSGE model," International Economics and Economic Policy, Springer, vol. 19(3), pages 581-614, July.
    • Handle: RePEc:kap:iecepo:v:19:y:2022:i:3:d:10.1007_s10368-022-00528-7
    DOI: 10.1007/s10368-022-00528-7
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