Department of Economics Working Papers,
Vienna University of Economics and Business, Department of Economics

Abstract: We augment an overlapping generations endogenous credit cycle model with an environmental sector and study the interplay between fiscal and financial environmental regulation, which ultimately affects environmental quality, macroeconomic stability, and income distribution. We define environmental quality as the amount of pollution emitted, which can be regulated either by financial constraints on polluting projects (environmental haircuts) or by tax-financed investment in abatement and improvement technologies. We find that environmental haircuts and environmental taxes each affect emissions and income distribution in unique ways, with interaction effects that reveal trade-offs between economic stability, income, and environmental outcomes. Compared to scenarios in which only financial regulations are implemented, the introduction of a supplementary environmental tax on emissions maintains similar environmental standards, but leads to higher total income and capital per worker. However, this shift in income distribution favors green investors, while the older generation, which relies more on capital income, may experience an overall decrease in net income.

Keywords: Green transition, environmental regulation, economic stability, income distribution, nonlinear model

JEL-codes: C61; C62; E32; Q52; Q58 December 2024

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