Optimal emission taxes and climate change in a DSGE framework

This thesis investigates the dynamics of optimal carbon emissions taxation under uncertainty in a Dynamic Stochastic General Equilibrium model from the literature, integrated with a climate module to allow for climate economy interactions. In the model, energy use in production raises atmospheric carbon concentrations, increasing global temperature and damaging productivity. dynamic Pigouvian tax on energy, set equal to the present value of future marginal climate damages so as to implement the first best planner allocation. The model is simulated to study the tax’s response to three stochastic shocks, namely productivity, energy prices, and the carbon stock. The results show that the optimal tax is procyclical, rising in good times to control emissions and falling in downturns. This dynamic adjustment acts as a stabilizer, modestly reducing business cycle volatility and insulating the economy from energy price shocks. The long-run steady state under the optimal tax features a significantly lower carbon stock alongside higher consumption, output, and leisure compared to laissez-faire. The analysis concludes that a dynamically adjusted carbon price can simultaneously mitigate climate damage and contribute to macroeconomic stability.