Munich Personal RePEc Archive

The Optimal Mix of Monetary and Climate Policy

Chen, Chuanqi and Pan, Dongyang (2020): The Optimal Mix of Monetary and Climate Policy.

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Abstract

Given central banks' recent interest in "greening the financial system", this research theoretically investigates the relationship between monetary and climate policy and tries to find their “optimal mix”. We build an Environmental Dynamic Stochastic General Equilibrium (E-DSGE) model with the consideration of illegal emission which is pervasive in many countries. According to the model, we find: First, the dynamic of monetary policy is influenced by the selection of regimes of climate policy and the effectiveness of enforcement of environmental regulation. Second, the coefficients in the traditional Taylor rule of monetary policy can be better set to enhance welfare when a certain regime of climate policy is given in the economy. This helps find the constrained optimums of a policy mix. Third, if the mitigation of climate change is augmented into the target of monetary policy, the economy’s welfare can be enhanced. However, under certain circumstances, a dilemma in such monetary policy makes it incompatible with the traditional mandate of central bank.

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