Modelling monetary and fiscal policy to achieve climate goals

This study develops a two-sector dynamic stochastic general equilibrium model with financial accelerator frictions, following Bernanke et al. (1999), to examine how monetary, financial, and fiscal instruments can steer bank lending toward climate-related objectives. The model distinguishes between green and brown production sectors and evaluates three finance-based policy tools: broad reserve requirements, targeted central bank refinancing for green lending, and government guarantees for loans to low-carbon firms. To benchmark these instruments against a standard environmental policy, the model also introduces a Pigouvian carbon tax that prices sectoral emissions according to their emission intensities. The results show that reserve requirement policy mainly operates through aggregate liquidity and generates relatively high transitional volatility, with limited long-run reallocation toward green activity. Targeted green refinancing is the most stable and effective finance-based instrument: it compresses the external finance premium for green firms, reallocates credit toward cleaner production, and delivers more persistent emission reductions. Government loan guarantees also support green lending and technological accumulation, but their transition dynamics are more oscillatory and may generate short-run scale effects. The Pigouvian carbon-tax benchmark clarifies that direct carbon pricing and green financial policies operate through different margins: the former raises the production cost of emissions-intensive activity, while the latter lowers the financing cost of green investment. These findings highlight the importance of targeted financial interventions and carbon-pricing benchmarks in designing policy frameworks for the low-carbon transition and financial stability.