Climate-Conscious Monetary Policy

Anton Nakov and Carlos Thomas

Journal of Political Economy Macroeconomics, 2026, vol. 4, issue 2, 385 - 424

Abstract: We study the implications of climate change and mitigation measures for optimal monetary policy in a New Keynesian model with climate externalities. When set at their socially optimal level, carbon taxes pose no trade-offs: fully stabilizing inflation and the welfare-relevant output gap is both feasible and optimal. If carbon taxes are suboptimal, trade-offs arise between core and climate goals, but they are resolved overwhelmingly in favor of price stability—even in scenarios of decades-long transitions to optimal carbon taxation. This reflects interest rate policy’s inefficiency as a climate instrument. In an extension with financial frictions, “green quantitative easing” is optimal but has limited impact on emissions due to small eligible bond spreads.

Date: 2026
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