Climate Policy and The Energy Transition

2026-06-17

AI Summary

This study investigates how to minimize macroeconomic transition costs during deep decarbonization, with a focus on dynamic frictions in energy use and capital reallocation. The authors develop a multi-sector dynamic general equilibrium model that incorporates renewable and non-renewable energy, sectoral heterogeneity in capital adjustment costs, household energy demand, and endogenous fossil fuel extraction. Their analysis shows that gradual emissions cap policies substantially reduce transition costs, increasing social welfare by 2.26% under economy-wide regulation and by 5.06% when regulation targets only firms. While subsidies for renewables and taxes on fossil fuels stimulate green capital accumulation, they cannot fully offset the costs of front-loaded policy tightening. The model also endogenously reveals the mechanism behind stranded fossil assets: their value declines as the shadow price of reserves falls in response to anticipated climate policies.

Abstract

This paper studies the macroeconomic dynamics of climate policy in a multi-sector dynamic general equilibrium model with renewable and non-renewable energy, sector-specific capital adjustment frictions, household energy demand, and endogenous fossil resource dynamics. The central mechanism is that decarbonization requires reallocating energy use and installed capital: fossil energy demand can contract immediately, while renewable capacity and abatement adjust only gradually. The analysis delivers four results. First, gradual policy implementation sharply reduces transition costs: relative to immediate implementation, gradual emissions caps improve welfare by 2.26 percentage points under comprehensive regulation and by 5.06 percentage points under firm-only regulation. Second, renewable energy subsidies and non-renewable energy taxes support renewable capital accumulation and reduce, but do not eliminate, the welfare cost of front-loaded tightening. Third, sectoral coverage changes the welfare ranking across implementation speeds. Firm-only regulation performs better under gradual implementation because it shields utility-relevant household energy services, but becomes nearly as costly as the carbon-price-only transition under immediate implementation. Fourth, endogenous fossil exploration and stock-dependent extraction costs transmit climate policy into lower extraction, fewer discoveries, and a declining shadow value of reserves, providing a structural mechanism for stranded fossil assets. The results show that deep decarbonization can be achieved at substantially lower macroeconomic cost when policy manages the speed and incidence of energy-capital reallocation.

Problem

• climate policy
• energy transition
• decarbonization
• macroeconomic cost
• capital reallocation

Innovation

• dynamic general equilibrium
• capital reallocation
• endogenous fossil resources
• gradual climate policy
• stranded assets