A DSGE analysis of green transition policies in the Euro Area
The paper by Pablo Garcia, Pascal Jacquinot, Črt Lenarčič, Kostas Mavromatis, Niki Papadopoulou, and Edgar Silgado-Gómez presents an extended version of the Euro Area and Global Economy (EAGLE) dynamic stochastic general equilibrium (DSGE) model, renamed C-EAGLE, which incorporates a comprehensive energy sector to analyze climate policies promoting the green energy transition. The model covers three regions: the Euro Area (EA), the United States (US), and the rest of the world (RW).
The model distinguishes between:
- Brown energy firms: Use brown capital and labor to produce carbon-emitting energy goods
- Green energy firms: Use green capital and labor to produce emission-free energy goods
Both sectors operate under monopolistic competition with price stickiness following Calvo pricing mechanisms.
The model includes two types of households:
- Financially unconstrained (Ricardian) households: Have access to asset markets and can accumulate three types of capital (regular, brown, and green)
- Financially constrained (non-Ricardian) households: Lack access to capital markets and rely on money holdings for consumption smoothing
The model incorporates several climate policy tools:
- Carbon taxes imposed as surcharges on brown energy prices
- Brown capital income taxes on returns from brown capital investments
- Revenue redistribution schemes targeting green energy firms and financially constrained households
Carbon tax effects
- Without revenue redistribution: Carbon taxes act as supply shocks, reducing output and raising inflation while causing euro appreciation and trade balance deterioration. Energy markets see substitution from brown to green production.
- With revenue redistribution: Redirecting one-third of revenues to green energy firms strengthens the transition and moderates recessionary effects by reducing green energy costs. Transfers to financially constrained households boost consumption but don’t accelerate the green transition.
Energy market dynamics
Brown energy markets experience disinflationary effects as demand pressures dominate supply-side impacts, reducing pre-tax brown energy inflation even as output falls. Green energy markets face higher inflation without redistribution due to increased demand, but targeted subsidies reverse this by expanding supply and easing price pressures.
Global coordination effects
Globally coordinated carbon taxes deliver only modest additional macroeconomic effects compared to unilateral EA action, as substitution in energy use outweighs international spillovers. The euro appreciates less under global coordination, leading to higher non-energy inflation and sharper consumption declines.
Brown capital income taxes
Unlike carbon taxes, brown capital income taxes generate both lower output and lower inflation, acting as negative demand shocks. When revenues are recycled to subsidize green capital investment, the shift toward green energy strengthens while moderating economic contractions.
Green transition in the Euro area: domestic and global factors
Authors: Pablo Garcia, Pascal Jacquinot, Črt Lenarčič, Kostas Mavromatis, Niki Papadopoulou, Edgar Silgado-Gómez
From: Bank of Spain
Managing the green transition: lessons from Wartime Economics
This working paper by Alexandre Chirat and Basile Clerc introduces the concept of a “Climate War Economy” (CWE) to understand the medium-run macroeconomic challenges of the green transition. Drawing on World War II war economies as a historical precedent, the authors examine how similar structural supply-demand imbalances might emerge during decarbonization. The authors argue that the green transition will create a structural disequilibrium similar to wartime economies. On the supply side, deliberate retirement of carbon-intensive assets, resource reallocation time lags, and climate disruptions will constrain productive capacity. Simultaneously, massive green investment requirements and employment effects will stimulate aggregate demand, resulting in medium-term inflationary pressures lasting 5-8 years.
Main arguments:
- The authors find that during WWII, price and quantity controls achieved three types of efficiency: social efficiency through more equitable resource distribution, productive efficiency by maintaining production incentives while controlling inflation, and allocative efficiency by enabling faster resource reallocation than market mechanisms during rapid structural transformation. The implication is that conventional monetary policy alone may prove insufficient for managing green transition inflation, as price signals during shortages can actually work against transition objectives by attracting investment back to carbon-intensive sectors experiencing scarcity-driven price increases.
- Chirat and Clerc advocate for reintegrating administrative controls into macroeconomic policy toolkits, including targeted price ceilings, non-linear pricing mechanisms for “chosen scarcity,” and coordinated national economic planning. They emphasize that successful implementation requires substantial administrative capacity, democratic governance frameworks, and building collective commitment analogous to wartime solidarity.
Obviously, the war economy analogy faces important constraints: temporal differences (wars end while climate transition is permanent), political legitimacy challenges in building “climate patriotism,” and substantial implementation requirements for administrative capacity and political consensus. Nevertheless, this paper challenges conventional reliance on monetary policy alone and advocates for a broader policy toolkit informed by successful historical precedents of rapid economic transformation.
A “Climate War Economy”? Medium-run Macroeconomic Disequilibrium of the Green Transition
Authors: Alexandre Chirat, Basile Clerc
From: Université Marie et Louis Pasteur, Université Paris Nanterre
