Climate Actions, Market Beliefs, and Monetary Policy

This paper studies the role of expectations and monetary policy in shaping the response ofthe economy to climate actions. We show that in a stochastic environment and without thestandard assumption of perfect rationality of agents, there is more uncertainty regardingthe time-path and the impact of a climate policy on the economy. The state of theeconomy and market beliefs determine the effectiveness of a mitigation plan implementedthrough carbon pricing. Climate actions may be frustrated by the presence of agentslacking the cognitive abilities necessary to form rational expectations. Monetary policymay reduce the uncertainty surrounding the impact of climate policies and may supportthe greening process