The green transition: impact on energy prices and macro outcomes

The macroeconomics of the green transition

Boehl et al., in this paper, investigate the macroeconomic effects of transitioning from fossil fuels to renewable energy through carbon taxation, using a medium-scale DSGE model with three key extensions:

1. Energy production sectors (brown vs green energy)
2. Endogenous innovation in green technology via R&D
3. Monetary policy analysis under a standard Taylor rule

The model structure includes energy as a production factor alongside labor and capital and a permanent tax on brown energy to create price distortions and incentivize green adoption. Green sector productivity improvements are endogenous and achieved through R&D-driven innovation. Finally, the authors simulate transition dynamics under varying tax rates (1%-50%) and monetary policy stances. Their findings include:

• Short-term effects
  The brown tax resembles a supply-side shock, causing:
  – Inflation surge (up to 3% annualized initially).
  – Higher energy prices and reduced consumption.
  – Immediate shift from brown to green energy production begins.
• Medium-term dynamics
  Innovation in green technology:
  – Accelerates due to higher R&D investment driven by green sector profits.
  – Reduces energy costs over time, easing inflationary pressures.
  – Monetary policy critically influences transition speed: weaker inflation stabilization (lower Taylor rule weight on inflation) allows temporary inflation, boosting R&D and accelerating transition.
• Long-term outcomes
  – New steady state features higher green energy share (up to ~60% at 100% tax rate).
  – Output and consumption rise permanently due to sustained R&D and lower energy costs.
• Welfare trade-offs
  – Optimal tax rate: ~30% maximizes welfare by balancing consumption gains and labor disutility.
  – Monetary policy: Lower inflation stabilization between 1.5-3.5, is optimal for most tax rates, except extremes.
• Sensitivity Analysis
  – Innovation efficiency: Slower R&D reduces transition benefits, favoring tighter inflation control.
  – Price rigidities: Less rigid prices diminish monetary policy’s impact on transition dynamics.
  – Output gap targeting: Complements inflation stabilization but optimal weight declines with higher tax rates.

The study concludes that while green transitions involve short-term costs, monetary policy flexibility and innovation incentives are pivotal for achieving long-term gains without destabilizing inflation.

The macroeconomics of green transitions
Authors: Gregor Boehl, Flora Budianto, Előd Takáts
From BIS

The green transition and energy prices

Acharya et al. develop a general equilibrium model to study how climate transition risks affect energy prices and valuations of different firms in the energy sector. The authors build a two-period model with three types of energy firms:

1. Incumbent fossil fuel firms with existing reserves
2. New entrant fossil fuel firms that must invest in exploration
3. Renewable energy firms

They also analyze three sources of climate transition risk:

1. Restrictions on developing new fossil fuel capacity
2. Possible future taxes on carbon emissions
3. Potential technological breakthroughs in renewable energy

The theoretical predictions are then tested empirically using novel climate transition risk news indices constructed from New York Times articles using GPT-4, stock returns of fossil fuel and renewable energy firms as well as oil futures prices.

Key findings:

• Different transition risks can have distinct and sometimes counterintuitive effects:
  – Restrictions on new fossil fuel capacity increase current energy prices.
  – Carbon taxes can decrease or increase current prices depending on their level.
  – Renewable breakthroughs generally decrease current fossil fuel prices.
• Uncertainty about future transition risks is crucial in driving some effects, like potential reversals of the “green paradox” – whereby expectations of higher future carbon taxes actually lead to more emissions today .
• Transition risks affect fossil fuel firms differently based on their existing reserves. In particular, firms with more developed reserves (“incumbents”) are less negatively impacted than those with undeveloped reserves (“entrants”).
• Empirically, the authors find:
  – Renewable energy stocks respond positively to news about emission costs and renewable breakthroughs.
  – Fossil fuel stocks respond negatively, with larger declines for firms with less developed reserves.
  – Oil futures prices generally decline with news of renewable breakthroughs and increase with news of emission costs.
• The model highlights how transition risks can amplify price differences between electrifiable and non-electrifiable energy markets.

Climate Transition Risks and the Energy Sector
Authors: Viral V. Acharya, Stefano Giglio, Stefano Pastore, Johannes Stroebel, Zhenhao, Tan, Tiffany Yong
From: New York University – Stern, Yale University – SOM