Build Back Better: The Role of Green Monetary and Fiscal Policies

Abstract We establish a two-sector model to simulate the potential effects of green fiscalpolicies and unconventional green monetary policy on the economy during a recoveryor in case of a stimulus policy. We find that instruments such as carbon tax, implicittax on brown loans, and subsidy for the purchase of green goods are all found to bebeneficial to the green sector in contrast to green quantitative easing. The carbon taximposed directly on firms in the brown sector is the most efficient tool to reduce pollution.More importantly, the marginal effects of green instruments on the economydepend on consumer preferences. Namely, the marginal effects are the most prominentwhen consumers start to develop the habit of purchasing green goods. Furthermore,the effects of environmental policies are more efficient when the elasticity of substitutionbetween green and brown goods increases. This finding suggests that raisingconsumers’ awareness and ability to consume green goods reinforce the efficiency ofpublic policies designed for low-carbon transition of the economy.