An energy-sector DSGE approach to assess Climate Change impacts on GDP Growth and Inflation

The main purpose of this paper is to assess the impact of climate change on GDP growth and inflation in a small, closed economy, also assessing the role that price rigidities have when responding to those changes. The impact will be measured in a simulated economy during the transition phase towards renewable energy sources. In order to do so, I will use a medium-sized DSGE model enriched with energy as a factor of production; it will feature a final good sector and three intermediate sectors, along with a representative household. The impacts will be evaluated first with imperfect competition only in intermediate sectors, then introducing it also in the final good sector. The parameters of the model are mostly borrowed from existing literature, except for those who are strictly related to climate scenarios; in this case, the estimation is conducted with linear regression using public and restricted data from international organizations, such as the IPCC and IEA. In both cases, climate change will be modeled as a shock on total factor productivity and a shock on taste shifter parameter. With a perfectly competitive final sector, results show that the impacts of taste-shifting shocks are much larger than those affecting the supply side and smaller shocks on demand are able to offset the impacts of a negative shock on total factor productivity. Regarding inflation, it only appears to be influenced by shocks on supply side of the economy. On the other hand, with monopolistic competition in the final sector as well, both shocks appear to be a significant driver of GDP when negative, climate change impacts also appear to be smaller. Again, inflation does not show a clear trend in response to negative shocks, its volatility is higher than GDP but variations around steady state are smaller in every climate scenario, with and without price rigidities in final sector.