Climate policy, energy inflation, and mandated abatement: An energy New Keynesian DSGE Model

Working Paper 939

Abstract

This paper develops an energy NK-DSGE model to study the macroeconomic effects of climate policy in a coal-intensive, price regulated economy --  South Africa. The model introduces a distinct energy-producing sector with nominal price rigidities, allowing energy marginal costs and energy inflation to pass through to aggregate CPI inflation. It also distinguishes between voluntary firm-level abatement and mandated abatement linked to public energy investment. The results show that productivity gains are not automatically green: lower energy costs stimulate energy production and raise emissions unless offset by policy intervention. A higher carbon tax reduces emissions, but temporarily raises both energy inflation and CPI inflation through the cost-push channel. Mandated abatement mitigates the simultaneous increase emissions due to public investment in the energy sector, it however crowds out voluntary firm abatement. Comparing alternative carbon tax rules, an autoregressive rule delivers stronger emissions reduction, whereas an emissions-targeting rule stabilises inflation more rapidly. The findings highlight the importance of combining carbon pricing, public investment, and credible abatement mandates to achieve decarbonisation while preserving macroeconomic stability.