Climate Change

The middle class can play a pivotal role as a growth driver in achieving Indonesia’s Golden Vision of becoming a high-income country by 2045. However, it remains narrow, at under 20 percent of the total population. It is also highly vulnerable, given a waning purchasing power, and unfavorable labor market dynamics. In contrast with the steady progress of the bottom half of the income distribution, the middle-class share has declined since 2019, driven, inter alia, by labor market shifts toward informality, falling real incomes, pandemic scarring. Reversing this trajectory requires broad-based structural reforms focused on revitalizing private-sector led growth, including investment to create formal sector jobs, aligning education with labor market needs and develop skills to raise economic sophistication, and enhancing productivity and resilience. Reforms that enhance the ease of doing business, such as reducing regulatory barriers and uncertainty and improving governance, can help facilitate convergence to high-income status and benefit the middle class.

This paper documents that households with higher marginal propensities to consume (MPCs) tend to consume goods with more flexible prices. Consequently, they face more cyclical and volatile inflation and experience higher inflation following an expansionary monetary policy shock. We embed this MPC-price stickiness relationship into a tractable multi-sector Two-Agent New Keynesian (TANK) model and analytically demonstrate that it dampens the effectiveness of monetary policy, reducing its efficacy by about 15% relative to a benchmark model with homogeneous consumption baskets. Introducing heterogeneous baskets also generates an inherently inefficient flexible-price equilibrium, which gives rise to a novel trade-off between stabilization and redistribution. The optimal monetary policy therefore differs qualitatively from the standard TANK policy prescription.

Sri Lanka was hit by catastrophic Cyclone Ditwah on November 28, claiming more than 600 lives as of December 6 and affecting millions more. Severe flooding and landslides displaced over 100,000 people and caused extensive destruction of houses, roads, bridges, rail lines, buildings including schools and hospitals, and agricultural land nationwide. The natural disaster creates urgent humanitarian and reconstruction needs, leading to acute balance-of-payments (BOP) pressures. The cyclone hit as Sri Lanka is emerging from a deep economic crisis and the IMF-supported reform program under the Extended Fund Facility (EFF) begins to bear fruit.

This paper provides a bi-annual assessment of efficient fossil fuel prices and subsidies for 170 countries, based on a comprehensive analysis of environmental and other externalities from fuel consumption. Globally, explicit (or fiscal) subsidies were $725 billion (0.6 percent of GDP) in 2024. Implicit subsidies, primarily underpricing of environmental costs, were $6.7 trillion (5.8 percent of GDP), with three quarters from underpriced air pollution and climate change.* Relative to GDP, explicit subsidies have stablized at pre-COVID levels while implicit subidies have increased somewhat and are expected to rise gradually until 2035. Explicit subsidy removal would reduce CO2 emissions by six percent below baseline levels in 2035, avoid 70,000 premature air pollution deaths annually, raise 0.6 percent of GDP in government revenue, and generate net economic benefits worth 0.5 percent of GDP. Removal of both explicit and implicit subsidies (through corrective taxes) generates substantially larger benefits, such as 1.1 million fewer premature air pollution deaths and a 46 percent reduction in CO2 emissions, but would be politically difficult. Subsidizing fuels is an inefficient way to support low-income households: for every dollar spent on explicit fuel subsidies, the poorest 20 percent of households receive just 8 cents.

Brazil’s landmark VAT reform, approved in December 2023, will profoundly alter the way consumption taxes are raised across three levels of government. The dual VAT will replace five overlapping taxes, address major inefficiencies of the current system, and simplify and harmonize a widely scattered tax landscape. While the objective of revenue neutrality is anchored in the reform law, deep structural changes will generate uncertainty about the expected revenue collection. This paper estimates consumption tax revenues under the new VAT based on an adjusted IMF's RA-GAP framework taking into account Brazil’s specificities and documents sectoral shifts in tax burdens. We simulate a wide set of scenarios, modifying key assumptions including on the compliance gap and informality, while being guided by legislated decisions on rates and exemptions. Our findings indicate that minimizing the compliance gap will be the most effective way towards ensuring revenue neutrality. To address revenue risks and unleash the reform’s benefits, full integration of operations and effective management of the input tax credit mechanism are critical.

This paper analyzes the effectiveness of green financial policies—green credit policies and free emissions allowances—at improving emission efficiency while supporting output. We develop a heterogeneous-firm model with financial constraints and endogenous adoption of cleaner capital. The model matches key targeted and untargeted moments from granular micro-data, including the facts that more financially constrained firms are less productive, more emission intensive, and respond less to carbon pricing. In counterfactual simulations in our model, credit policies without green bias raise output but also raise emissions, as firms become more capital and energy intensive. In contrast, well-targeted green credit policies—focusing on frontier technologies—cut emissions while boosting output. In the presence of financial frictions, free emissions allowances offset the output costs of carbon pricing, breaking the usual irrelevance of permits allocation.