Model Comparison › Macroeconomic Optimization

Formal Macroeconomic Optimization (DSGE / CGE)

Calibrated New Keynesian DSGE model with climate-sector extensions. Three-equation core (IS curve, Phillips curve, Taylor rule) augmented with physical damage shocks, carbon cost pass-through, stranded-asset write-downs, and labour productivity effects. Compares three climate policy pathways.

SCENARIO:

SHOCK:

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Warming by 2050

°C above pre-industrial

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Cumulative Output Loss

Sum of negative output gaps (pp×yr)

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Peak Output Gap

Worst single-year output gap (%)

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Avg Inflation

Annual average 2025–2050 (%)

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Carbon Price 2050

USD/tCO2

Output Gap & Inflation — All Three Scenarios

Output Gap Components (Selected Scenario)

Impulse Response Function

Model Equations

IS Curve: x_t = E[x_t+1] − σ⁻¹(i_t−E[π_t+1]−r*) + φ_climate + φ_strand
Phillips Curve: π_t = βE[π_t+1] + κx_t + ε_carbon
Taylor Rule: i_t = r* + φ_ππ_t + φ_xx_t

σ=1.5 (IES inverse) | κ=0.13 (NKPC slope)
φ_π=1.5 | φ_x=0.5 (Taylor coefficients)
β=0.97 (annual discount factor)

φ_climate = −ΔDamage × 8.0 (incremental physical shock)
ε_carbon = P_CO2 × 0.00004 (supply inflation from carbon price)

Christiano, Eichenbaum & Evans (2005) DSGE calibration · Burke et al. (2015) climate-GDP damage · NGFS Phase IV macroeconomic scenarios · Dietz & Stern (2015) damage model. Simplified quasi-linear approximation; full RE solution requires matrix methods.

Sources: Christiano, Eichenbaum & Evans (2005) "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy" JPE · Burke, Hsiang & Miguel (2015) "Global non-linear effect of temperature on economic production" Nature · NGFS Phase IV (2023) Macroeconomic Scenarios · IMF World Economic Outlook (2020) "Climate Change and the Macro-Economy" · Dietz & Stern (2015) "Endogenous Growth, Convexity of Damages" EJ. Note: This is a simplified illustrative DSGE — a full production model would require calibrated rational-expectations matrix solution and sector-level disaggregation.