The Emission-Reduction Effect of Green Demand Preference in Carbon Market and Macro-Environmental Policy: A DSGE Approach

Abstract

Along with the new stage of prevention and control of the COVID-19 pandemic and the vision and goals of combatting climate change, the challenges of the transition to a green economy have become more severe. The need for green recovery of the economy, stability and security of energy production and consumption, and the coordination of low-carbon transformation and socio-economic development has become increasingly urgent. This paper proposes a new theoretical framework to study the effect of carbon emission reduction on the mutual application of the carbon market, fiscal policy and monetary policy under the non-homothetic preference of energy product consumption. By constructing an environmental dynamic stochastic general equilibrium (E-DSGE) model with residents’ non-homothetic preferences, this paper finds that coordinating the carbon market and macroeconomic policies can achieve economic and environmental goals. However, the transmission paths for each are different. The carbon market influences producers’ abatement efforts and costs through carbon prices. Monetary policy controls carbon emissions by adjusting interest rates, while fiscal policy controls carbon emissions by adjusting total social demand. Improving non-homothetic preferences will amplify business cycle fluctuations caused by exogenous shocks, thus assuming the role of a “financial accelerator”. Further research shows that non-homothetic preferences influence the heterogeneity of different policy mixes. Finally, this paper discovers that the welfare effects, the relative size and difference of long-term and short-term effects resulting from the different policy mixes, also depend on the level of non-homothetic preferences. The intertemporal substitution mechanism due to the improvement of non-homothetic preferences endows low-carbon production with “option” characteristics. Our study reveals the role of non-homothetic preferences on the effectiveness of policy implementation. It highlights the importance of matching monetary and fiscal policies with the carbon market based on the consumption and production side. It provides ideas for policy practice to achieve the goal of “dual carbon” and promoting coordinated socio-economic development.