ClimatePolicyandtheEconomy:

EvidencefromEurope’sCarbonPricingInitiatives

DiegoR.K¨anzig

NorthwesternUniversity&NBER

MaximilianKonradt

GenevaGraduateInstitute

IMFERConferenceonTheFutureofMacroeconomicPolicy

June2023

1

Theloomingclimatecrisis

?Climatechangeisnowatthetopoftheglobalpolicyagenda

?Carbonpricingisincreasinglyusedasatooltomitigateclimatechange

?Carbontaxes

?Cap-and-trade

?Weknowlittleabouttheeffectsofthesepoliciesinpractice

?Effectiveatreducingemissions?

?Short-termeconomiccosts?

?Howdodifferentpoliciescompare?

2

Thispaper

?ComprehensiveanalysisofcarbonpricingpoliciesinEurope

?WhyEurope?Globalleaderinclimatepolicywith20+yearsofexperience

?EU-wideemissionstradingscheme(EUETS)

?Manycountriesalsoenactedcarbontaxesatnationallevel

?Sufficientvariationtoidentifytheeffectsofinterest

?Keychallenge:Carbonpricesnotsetinavacuum

?Wecomparetwoempiricalstrategies:

?high-frequencyidentificationand“control-based”approach

?Provideunifiedframeworktostudyimpactofcap-and-tradeprices&carbontaxes

3

Mainresults

?Carbonpricingleadstoemissionreductionbutcomesateconomiccost

?Economiceffectslargerforcarbonmarketthanfornationalcarbontaxes

?Robusttotheidentificationstrategyused

?Inlinewithpreviousevidencein

K¨anzig(2022

)and

MetcalfandStock(forthcoming

)

?Welookintopotentialexplanationsforthisfinding

?Revenuerecycling

?Coverageandpass-through

?Spilloversandleakage

?Monetarypolicy

?

...

Mainresults

4

?Useofcarbonrevenuesturnsouttobecrucial

?Carbontaxesoftenintroducedaspartofbroadertaxreformloweringincometaxes

?Europeancarbonmarkethasnodirectmeasurestocushioneffectsonhouseholds→Carbontaxesthatdonotrecyclerevenuesdisplaystrongereconomiceffects

?Pass-throughandcoveragearealsoveryimportant

?Energysectorcoveredundercarbonmarket,excludedfromcarbontaxes

?Energy,consumerandproducerpricesincreasestronglyafterincreaseinEUETSprice,mutedpriceresponseafterequivalentincreaseinnationalcarbontaxes

?NationalcarbontaxeshavelimitedeffectonEUemissions;potentialcarbonleakage

Bothpoliciescanbesuccessfulatreducingemissionsbutmayhavetobe

complementedwithotherpoliciestocushioneconomicimpactsandpreventleakage

5

Additionalresults

?WeexploretheregionalimpactsoftheEuropeancarbonmarket

?Economicimpactsvarysubstantiallyby

1.Shareoffreeallowances

2.Concentrationofelectricitymarkets

?SouthernEuropeancountriesmostaffectedastheyreceiverelativelyfewfreeallowancesandtendtohaveconcentratedelectricitymarkets

?Today’spresentation:focusoncarbontaxversuscap-and-trade

6

Identification

?Carbonpricesareendogenous

?Simultaneity:weakeconomycouldinducegovernmenttoreducecarbonprice

?Confounders:othershockscouldaffectbothcarbonpriceandtheeconomy

?Twoapproachestoidentification

1.High-frequencyapproach:isolateimpactofpolicynewsoncarbonprices,useasIV

2.Control-basedapproach:controlforrelevanteconomicvariablestoisolateplausiblyexogenousvariationincarbonprices

7

High-frequencyidentification

?Idea:Collectrelevantpolicyeventsandlookatresponseofcarbonpricesintightwindowaroundpolicyevents(

K¨anzig,2022

)

Details

?Onlypossibleforcap-and-tradewherewehavehigh-frequencypriceinformation

?Challenge:high-frequencycarbonpolicysurprisesmaybeweakinstrumentsatlowerfrequencies(quarterly/annual)

?ByimposingVARstructure,wecanobtainanestimateofacarbonpolicyshock

?Shockmeasurecanbeaggregatedtothefrequencyofinterest,?Estimatedynamiccausaleffectsusinglocalprojections:

8

Carbonpolicyshocks

Percent

-4-2024

2000200520102015Year

Figure1:CarbonPolicyShocksintheEuropeanCarbonMarket

?instrumentbycarbonpolicyshockasrobustnesscheck

9

Control-basedidentification

?Idea:Controlforeconomicandfinancialvariablestoisolatesomeplausiblyexogenousvariationincarbonprices(

MetcalfandStock,forthcoming

)

?e.g.drivenbychangesinpoliticalpreferencesforambitiousenvironmentalpolicies,internationalclimatepolicypressure,orhistoricallylegislatedschedules

?EstimatedynamiccausaleffectsofETSpriceandcarbontaxusinglocalprojections:

Challenges:

?ForcarbonmarketmostvariationatEUlevel:cannotcontrolfortimeFE?forcarbontaxesweincludetimeFE,resultswithcontrolsverysimilar

?ETSpricesaremarketpricesandthusendogeneitybiggerconcern

showsEuropeancarbontaxes.BothareexpressedineuropermetrictonofCO2equivalent.

10

ETSpriceandcarbontaxrates

EUR/tCO2

0510152025

ETSprice

EUR/tCO2

050100150200

Carbontaxes

2000200520102015

DNKESP

ESTFIN

FRAGBR

IRLISL

LVANOR

POLPRT

SVNSWE

2000200520102015Year

Year

Figure2:CarbonPricesinEurope

Notes:TheleftpanelshowstheEUETSpricesinceitsintroductionin2005.Therightpanel

Notes:Darkandlightshadedareasare68and95percentconfidencebands.11

Percent

-4-20.2.4.6

HICP

01234

Years

Percentagepoints

-20.2.4

Unemploymentrate

01234

Years

RealGDP

Percent

-15-1-50.5

01234

Years

Industrialproduction

Percent

-15-1-50.5

01234

Years

TheeffectsofanEUETSpolicyshock

Percent

HICPenergy

-1012

01234

Years

Percent

-1-50.5

GHGemissions

01234

Years

Figure3:TheEffectsofanEUETSPolicyShock

Notes:Darkandlightshadedareasare68and95percentconfidencebands.12

Percent

-4-20.2.4.6

HICP

01234

Years

Percentagepoints

-20.2.4

Unemploymentrate

01234

Years

RealGDP

Percent

-15-1-50.5

01234

Years

Industrialproduction

Percent

-15-1-50.5

01234

Years

TheeffectsofaninnovationinEUETSprices

Percent

-1012

HICPenergy

01234

Years

Percent

-1-50.5

GHGemissions

01234

Years

Figure4:TheEffectsofaEuroIncreaseinEUETSPrices

13

Environmentalandeconomicimpactofthecarbonmarket

?High-frequencyandcontrol-basedapproachproduceconsistentresults

?Signsandmagnitudesconsistent,inlinewithresultsin

K¨anzig(2022

)

?Butenergypriceincreasemuchmorepersistentundercontrol-basedapproach?Differentvariationforidentification

?Instrumentingcarbonpricebycarbonpolicyshocksalsoproducessimilarresults

More

Percent

-4-20.2.4.6

HICP

01234

Years

Percentagepoints

-20.2.4

Unemploymentrate

01234

Years

RealGDP

Percent

-15-1-50.5

01234

Years

Industrialproduction

Percent

-15-1-50.5

01234

Years

TheoveralleffectsofEuropeancarbontaxes

Percent

-1012

HICPenergy

TimeFE

Globalcontrols

01234

Years

Percent

-1-50.5

GHGemissions

01234

Years

14

Figure5:TheEffectsofaEuroIncreaseinEuropeanCarbonTaxesNotes:Darkandlightshadedareasare68and95percentconfidencebands.

Percent

-15-1-50.5

Percent

-4-20.2.4.6

HICP

01234

Years

Percentagepoints

-20.2.4

Unemploymentrate

01234

Years

Industrialproduction

Percent

-15-1-50.5

01234

Years

RealGDP

1

4

3

0

2

Years

...andinNorthernandWesternEurope

Percent

-1012

HICPenergy

01234

Years

Percent

-1-50.5

GHGemissions

01234

Years

Figure6:TheEffectsofaEuroIncreaseinCarbonTaxesinNorthernandWesternEurope

Notes:Darkandlightshadedareasare68and95percentconfidencebands.

SouthernandEasternEurope

15

16

Takingstock

?ETSpricesandcarbontaxesleadtocomparableemissionreductions,buthavevastlydifferenteconomicconsequences

?Whatdrivesthesedifferences?Arecarbontaxesthemoredesirablepolicy?

?Exploredifferentexplanationstoaccountfordifferentialimpacts

1.Revenuerecycling

2.Coverageandpass-through

3.Spilloversandleakage

4.Monetarypolicy

17

Fiscalpolicyandrevenuerecycling

?Theorysuggestthatuseofcarbonrevenuescanbecrucialfortransmissionofcarbonpricing

?Alsorelevantinpractice

?Carbontaxesoftenintroducedaspartofbroadertaxreformloweringincometaxes

?Europeancarbonmarkethasnodirectmeasurestocushioneffectsonhouseholds

?Studyhoweffectsdifferincountriesthatdorecyclecarbonrevenuestocountriesthatdon’t

?Revenuerecycling:Denmark,Finland,NorwayandSweden

Fiscalpolicyandrevenuerecycling

01234

Percent

HICPenergy

Non-revenuerecyclingcountriesRevenuerecyclingcountries

01234

Years

Percent

-50.51

HICP

01234

Years

GHGemissions

Percent

-15-1-50.5

01234

Years

RealGDP

Percent

-2-15-1-50.5

01234

Years

Percentagepoints

-20.246.8

Unemploymentrate

01234

Years

Percent

-3-2-101

Industrialproduction

01234

Years

Figure7:TheRoleofRevenueRecycling

18

Notes:Darkandlightshadedareasare68and95percentconfidencebands.

Fiscalpolicyandrevenuerecycling

19

?Countriesthatdonotrecycletaxrevenuesexperiencestrongereconomiceffects

?Butemissionreductionsarecomparable

?Recyclingrevenuesdoesn’toffsetemissionreductionsbutcushionseconomiccosts

20

Coverageandpass-through

?StarkdifferenceinsectoralcoverageofEUETSandcarbontaxes

?Carbonmarketcoverspowersectorandenergy-intensiveindustry

?Pass-throughparticularlystronginpowersector(

FabraandReguant,2014

)

?Carbontaxesmainlyapplytotransportationandremainingindustrialsectors

Coverageandpass-through

21

4

PanelA:EUETS

Percent

-1012

HICPenergy

Percent

-4-20.2.4.6

HICP

01234

01234

Years

Years

Percent

4-202468

Oilprice

Percent

-1012

PPI

01234

-

0123Years

Years

PanelB:Europeancarbontaxes

Percent

-1012

HICPenergy

Percent

-4-20.2.4.6

HICP

01234

Years

01234

Years

Percent

-4-202468

Oilprice

PPI

01234

Percent

-1012

01234

Years

Years

More

Figure8:TheImpactonPrices

Coverageandpass-through

22

?EnergypricesincreasestronglyafterincreaseinEUETSpriceandarepassedontoproducerandconsumerprices

?Priceresponsesmutedafterequivalentincreaseinnationalcarbontaxes

23

Spilloversandleakage

?CarbonmarketisanEU-widepolicy,carbontaxesleviedatnationallevel

?StrongintegrationofEUcountriesmaycushioneconomiceffectsofnationalpolicies

?Nationalcarbontaxpoliciesmaybesubjecttoleakage,particularlyinmanufacturing

?WhatistheimpactonEU-wideemissions?

Spilloversandleakage

?Somesuggestiveevidenceforcarbonleakage

24

PanelA:EUETS

Percent

-1-50.5

TotalGHGemissions

01234

Years

PanelB:Europeancarbontaxes

Percent

-1-50.5

TotalGHGemissions

01234

Years

Figure9:TheEffectonEU-wideGHGemissions

?NationalcarbontaxesdonotleadtoasignificantfallinEU-wideemissions

25

Monetarypolicy

?MonetarypolicycouldalsoplayaroleinaccountingforthedifferenteffectsofEU-wideandnationalcarbonpricingpolicies

?HigherETSpricesleadtohigherEUinflation

?monetarypolicyleansagainstthesepressures

?Nationalcarbontaxesnotinflationary(letaloneatEUlevel)?nomonetaryresponse

Monetarypolicy

26

PanelA:EUETS

Percentagepoints

-4-20.2.4

Interestrates

Shortrates

Longrates

01234

Years

PanelB:Europeancarbontaxes

Percentagepoints

-4-20.2.4

Interestrates

Shortrates

Longrates

01234

Years

Figure10:TheEffectonInterestRates

?ECBleansagainstinflationarypressureincarbonmarket,nomonetaryresponsetocarbontaxes

27

Conclusion

?NewevidenceontheeffectsofcarbonpricinginEurope

?Policiessuccessfulinreducingemissions,butcomesateconomiccost

?Economiccostscruciallydependoncoverageandrevenueuse

?Complementcarbonpricingwithotherpoliciestocushioncostsandpreventleakage

Supplement

27

Thankyou!

Exampleevents

Table1:Regulatoryupdateevents(extract)

Carbonpolicysurprises

whereFt,dissettlementpriceoftheEUAfrontcontractoneventdaydinmonthtandPc-1isthewholesale

electricitypriceonthedaybefore

Back

Percent

-4-20.2.4.6

HICP

01234

Years

Percentagepoints

-20.2.4

Unemploymentrate

01234

Years

RealGDP

Percent

-15-1-50.5

01234

Years

Industrialproduction

Percent

-15-1-50.5

01234

Years

InstrumentingETSprices

Percent

HICPenergy

-1012

01234

Years

GHGemissions

Percent

-1-50.5

01234

Years

Figure11:TheEffectsofaEuroIncreaseinEUETSPrices,IVApproachNotes:Darkandlightshadedareasare68and95percentconfidencebands.

Back

Back

CarbontaxesinEuropeanregions

PanelA:WesternandNorthernEuropePanelB:SouthernandEasternEurope

EUR/tCO2

050100150200

Carbontaxes

EUR/tCO2

050100150200

Carbontaxes

ESP

PRT

POL

SVN

2000200520102015

Year

DNKEST

FINFRA

GBRIRL

ISLLVA

NORSWE

2000200520102015Year

Figure12:CarbonTaxesinEuropeanRegions

Notes:Darkandlightshadedareasare68and95percentconfidencebands.

Back

Percent

-20246

-10123

Percent

HICP

01234

Years

Percentagepoints

Unemploymentrate

-2-1012

01234

Years

Percent

-5051015

Industrialproduction

01234

Years

RealGDP

1234Years

0

EffectinSouthernandEasternEurope

Percent

HICPenergy

0246810

01234

Years

Percent

-50510

GHGemissions

01234

Years

Figure13:TheEffectsofaEuroIncreaseinCarbonTaxesinSouthernandEasternEurope

ETSshocksandoilprices

MIonthsMIonths

Figure14:TheEffectonOilProduction

Back

Regionalimpactofthecarbonmarket

?Untilnowwefocusedontheaverageimpactofcarbonpricing

?HowdotheeffectsoftheEUETSvaryacrossregions?

?Tostudythis,weconsiderdifferentexposurevariabesandincludeaninteractionterminourlocalprojections:

yi,t+h-yi,t-1=α+βhcpst+γhcpst*exposuret0-1+...+εi,t+h

?Considertwomainexposurevariables:

?Shareoffreeallowances

?Concentrationofelectricitymarket

Percent

-1-50.5

GHGemissions

01234

Years

Percentagepoints

-5-4-3-.2-10

Unemploymentrate

01234

Years

Theroleoffreeallowances

Percent

-1-50.5

HICPenergy

01234

Years

Percent

0246.8

RealGDP

01234

Years

Figure15:TheRoleofFreeAllowancesintheEUETS

Theroleofmarketconcentration

GHGemissions

HICPenergy

-20.24.6

-6-4-20.2.4

Percent

Percent

1

4

3

0

2

Years

01234

012.3.4

Percentagepoints

Unemploymentrate

01234

Years

Years

Percent

-6-4-20.2

RealGDP

01234

Years

Figure16:TheroleofMarketConcentrationintheEUETS

SecondquartileFirstquartile

FourthquartileThirdquartile

4