The New Keynesian Climate Model

To join the lecture via Zoom, please register here.

Climate change confronts economies with two inflationary challenges: climateflation, driven by physical climate impacts, and greenflation, arising from mitigation efforts. This paper develops and estimates a nonlinear New Keynesian Climate model that merges the long-term dynamics of Integrated Assessment Models with the business cycle fluctuations captured by DSGE frameworks. This unified framework enables a systematic analysis of how climate change and mitigation policies influence inflation, output, and interest rates. We find that nominal rigidities are crucial for determining optimal carbon pricing: neglecting them leads to miscalibrated carbon taxes, excessive inflation, and reduced consumption. Simulations also reveal that Paris-aligned mitigation paths generate higher inflation than laissez-faire approaches. Nonetheless, central banks can counter these inflationary pressures by adapting policy to a rising natural interest rate and accepting short-term GDP losses. These results highlight the need to align monetary frameworks with climate policy goals to ensure macroeconomic stability during the net-zero transition.