Monetary Policy, Neutrality, and the Environment

• Published date: 01 October 2023
• Author: JOAO R. FARIA,PETER MCADAM,BRUNO VISCOLANI
• Date: 01 October 2023
• DOI: http://doi.org/10.1111/jmcb.13002

DOI: 10.1111/jmcb.13002

JOAO R. FARIA

PETER MCADAM

BRUNO VISCOLANI

Monetary Policy, Neutrality, and the Environment

We study the interaction between monetary/scal policies in a Ramsey–

Sidrauski model augmented with the “Green Golden Rule.” We demon-

strate conditions whereby monetary and scal policy under different utility

and preference assumptions are or are not environmentally neutral. Despite

its nonseparability in utility, we demonstrate that moneyis environmentally

neutral. Policy impacts the environmentvia the marginal rate of transforma-

tion rather than the marginal rate of substitution between consumption and

environment. Fiscal policies under a balanced budget are environmentally

nonneutral. Only under a nonbalanced budget, when decits are monetized,

is money environmentally nonneutral. Under cash-in-advance and transac-

tions costs, money is environmentally nonneutral.

JEL E52, E62, H23

Keywords: Ramsey–Sidrauski, Green Golden Rule, environmentalcapital,

Chichilnisky et al.’s conjecture, cash in advance, transactions costs,

Friedman rule

“Climate change is an emerging risk to [..] the economy,and we are, as so many others

are, in the very early stages of understanding what that means, what needs to be done

about it and by whom.” Powell (2020).

“…[on the basis of the utilitarian approach]it is clearly irrational to be concerned about

global warming, nuclear waste, species extinction, and other long-run phenomena. Yet

we are worried about these issues, and are actively considering devoting very substan-

tial resources to them. Thereappears to be a part of our concern about the future that is

not captured by discounted utilitarianism.” Beltratti, Chichilnisky, and Heal (1993)

The authors thank two anonymous referees, the editor Sanjay Chugh, Carl Walsh(discussant), Graciela

Chichilnisky, John H. Cochrane, Jaime Orrillo, and numerous seminar participants for comments. The

opinions expressed are those of the authors and do not necessarily reect the views of the Federal Reserve

Bank of Kansas City or the Federal Reserve system.

J F is a Professor of Economics at the Collegeof Business at Florida Atlantic University (E-

mail: jfaria@fau.edu). P MA is a Senior Researchand Policy Advisor at the Research Depart-

ment at the Federal Reserve Bank of Kansas City (E-mail: peter.mcadam@kc.frb.or). B V

is a Professor of Mathematics at the University of Padova(E-mail: viscolani@math.unipd.it).

Received November 23, 2021; and accepted in revised form June 16, 2022.

Journal of Money, Credit and Banking, Vol. 55, No. 7 (October 2023)

© 2022 The Ohio State University.

1890 :MONEY,CREDIT AND BANKING

Climate change is recognized to be an urgent economic issue. Monetary policy-

makers, long silent on the subject, have now also vigorously joined the debate.1This

is important because high-level agreements on climate change (such as the 2021 G20

summit2) can only be carried out through specic governmental policies, which in-

evitably involve a combination of scal and monetary policies. However, little or no

discussion was made on how and which policy interactions may be required to reach

these goals.

Thus far, monetary policymakers’ interest in the consequences of climate change

has tended to lie with practical matters of nancial stability, “stress tests,” and macro-

prudential regulations. What has somewhat gone under the radar is the integration

of environmental interactions into the canonical set of theoretical monetary models:

for example, the money-in-the-utility function (MIUF), cash-in-advance (CIA), and

transaction cost (TC) approaches (see e.g., Walsh 2017). How would the presence of

environmental assets t into such frameworks? Is monetary or indeed scal policy

neutral with respect to the environment? Does the scal-monetary policy mix mat-

ter for the environment?3As far as we are aware, these links have yet to be made in

the literature.

To achieve this task, we depart from traditional monetary growth models such as

Sidrauski’s MIUF, CIA, and transactions cost approach (TCA) and combine them

with a simple mix of scal tools to examine whether and why money may matter

to protect the environment. Such an exercise would be straightforward. However,

we enrich our analysis by taking into account in these traditional frameworks novel

approaches such as the Green Golden Rule (GGR).

Our model adapts the Ramsey (1928) and Sidrauski (1967) MIUF frameworks to

include a proxy for environmental capital (Dasgupta and Heal 1974). The environ-

mental capital is a renewable environmental asset, A, which, alongside consumption

C, yields utility.4This environmental capital variable also enters as an argument in

production. Environmental considerations and the accompanying analysis of macroe-

conomic policies are of interest because they affect the long-term performance of the

economy (Hansen 2021). Accordingly, the particular perspective taken in this paper

is precisely to assess the long-run neutrality of macroeconomic policy with respect to

1. For example, Cœuré (2018), Mersch (2018), Olovsson (2018), NGFS (2019), Rudebusch (2019),

,2021), and Boneva, Ferrucci, and Mongelli (2022). See also Gillingham and Stock (2018) and Auffham-

mer (2018) for more general and recent analyzes of the economic impact of climate change.

2. At the 2021 G20 summit, it was agreed (i) on the need to reach net-zero greenhouse gas emissions;

(ii) to end public nancing for coal-red power generation abroad; and (iii) that the impacts of climate

change, such as extremestorms, oods, and rising sea levels,would be “much lower” if the average increase

in global temperature could be held to 1.5◦C(2.7

◦F). See g20.org/wp-content/uploads/2021/10/G20-Joint-

Finance-and-Health- Ministers-Communique-29-October-2021.pdf.

3. A literature on monetary-scal interdependence under policy extremes has emergedin recent years,

for example, Fujiwara and Ueda (2013).

4. Nordhaus and Boyer (2000) and Rezai, Foley,and Taylor (2009) consider the stock of greenhouse

gases as an additional state variable.