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Does a Recession Call for Less Stringent Environmental Policy? A Partial-Equilibrium Second-Best Analysis

Journal article
Authors Inge van den Bijgaart
Sjak Smulders
Published in Environmental and Resource Economics
Pages 1-28
ISSN 0924-6460
Publication year 2017
Published at Department of Economics
Pages 1-28
Language en
Links https://doi.org/10.1007/s10640-017-...
Keywords Credit constraints Credit shock Second-best optimal emission tax Productivity shock
Subject categories Economics

Abstract

This paper analyses second-best optimal environmental policy responses to real and financial shocks in a two-period partial equilibrium model with heterogeneous firms, an environmental externality, and credit constraints. We show that, to alleviate credit constraints and encourage investment, the second-best optimal emission tax falls short of marginal emission damages. The optimal response to shocks depends on how the shock affects the size of the environmental and credit market failures and the effectiveness of the tax in alleviating these market failures. Under mildly restrictive assumptions on functional forms, the optimal response to a (persistent) negative productivity shock or a tightening of credit is to reduce the emission tax. Our results are informative for how climate change policy should optimally change with the business cycle.

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