Further Delaying Climate Policies Will Hurt Economic Growth
IMF Blog, October 5, 2022
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Bibliographic details
- Authors: Benjamin Carton, Jean-Marc-Natal
- Published: October 5, 2022
Key findings
- The world must cut greenhouse gas emissions by at least a quarter before the end of this decade to achieve carbon neutrality by 2050.
- A budget-neutral policy package (greenhouse gas taxes + transfers to households, subsidies to low-emitting technologies, and labor tax cuts) phased in immediately and over eight years would:
- Slow global economic growth by 0.15 percentage point to 0.25 percentage point annually from now until 2030.
- Raise inflation moderately in most regions by 0.1 percentage point to 0.4 percentage point.
- For Europe, the United States, and China, average costs over eight years range between 0.05 percentage point and 0.20 percentage point.
- Fossil-fuel exporters and energy-intensive emerging market economies face the highest costs and drive results for the rest of the world.
- Partially credible climate policies could almost double the cost of transitioning to renewables by 2030.
- Delaying implementation until 2027 (while still achieving the same long-term cumulative emissions reduction) would:
- Require a more rapid phase-in and a higher greenhouse gas tax because emissions accumulate from 2023 to 2026.
- Even with credible monetary policy and rapid electricity decarbonization, GDP would have to drop by 1.5 percent below baseline over four years to drive inflation back to target.
- Delay beyond 2027 would require an even more rushed transition, with inflation containable only at significant cost to real GDP.
- Policymakers should weigh short-term transition costs against potential long-term output losses from unchecked climate change, which could be orders of magnitude larger according to some estimates.
Model and assumptions
- The analysis uses a model that splits countries into four regions: China, the euro area, the United States, and a block representing the rest of the world.
- Each region introduces budget-neutral policies combining:
- Greenhouse gas taxes increased gradually to achieve a 25 percent reduction in emissions by 2030.
- Transfers to households.
- Subsidies to low-emitting technologies.
- Labor tax cuts.
- The macroeconomic cost depends on how quickly regions can wean off fossil fuels for electricity generation; a more difficult transition requires larger greenhouse gas tax increases or equivalent regulations.
Regional impacts and distributional considerations
- Global average growth cost: 0.15 percentage point to 0.25 percentage point annually (now until 2030).
- Europe, the United States, China: 0.05 percentage point to 0.20 percentage point on average over eight years.
- Highest costs borne by fossil-fuel exporters and energy-intensive emerging market economies.
- Policy implication: increased international cooperation on finance, technology, and know-how transfer—especially for low-income countries—to reduce global costs.
Inflation, monetary policy, and credibility
- Gradual and credibly implemented climate mitigation policies:
- Give households and firms time and motive to transition.
- Require monetary policy adjustments to keep inflation expectations anchored.
- Pose smaller and more manageable costs for central banks than typical supply shocks that cause sudden energy-price surges.
- Central bank choices illustrated for the United States:
- Stabilize a price index that includes greenhouse gas taxes, which would cost an additional 0.1 percentage point of growth annually.
- Or let the tax fully pass through to prices.
- If monetary policy loses credibility and inflation expectations de-anchor, climate policies could trigger second-round effects, significantly raising the output-inflation trade-off.
- Analytical chapter guidance: design climate policies to curb the greenhouse gas tax’s impact on inflation using subsidies, feebates, or labor tax cuts.
Delayed implementation scenario and implications
- Scenario: delay implementation until 2027, achieve same long-term cumulative emissions reduction via faster later cuts.
- Consequences:
- Requires higher greenhouse gas taxes and a steeper emissions decline to offset emissions accumulated from 2023 to 2026.
- Even under favorable conditions (credible monetary policy; rapid electricity decarbonization), GDP would need to drop by 1.5 percent below baseline over four years to bring inflation back to target.
- Further delay beyond 2027 increases the severity of the required rapid transition and raises the cost to real GDP.
Policy recommendations and design principles
- Implement climate mitigation policies now and phase them in gradually to minimize near-term macroeconomic costs.
- Ensure policy credibility so firms and households internalize future tax paths in investment decisions; partial credibility substantially raises transition costs.
- Coordinate internationally to share finance, technology, and know-how—particularly to support low-income countries and reduce global adjustment costs.
- Use policy instruments that offset inflationary pressure from greenhouse gas taxes, such as subsidies, feebates, or labor tax cuts.
- Central banks should adjust policy to keep inflation expectations anchored; stabilizing a price index that includes greenhouse gas taxes is one option albeit with modest growth costs.
Source: Further Delaying Climate Policies Will Hurt Economic Growth, Benjamin Carton and Jean-Marc Natal, October 5, 2022.