International Transmission of the Business Cycle and Environmental Policy

Abstract This paper presents a dynamic stochastic general equilibrium (DSGE) model of environmental policy for a two-country economy and studies the international transmission of asymmetric shocks considering two different economy-wide greenhouse gases (GHG) emission regulations: a carbon tax and a cap-and-trade system allowing for cross-border exchange of emission permits. We find that international spillovers of shocks are strongly influenced by the environmental regime put in place. The cross-border reaction to shocks is found to be magnified under a carbon tax. The pattern of trade and the underlying monetary regime influence the international transmission channels interacting with the environmental policy adopted.