## wpiea2024162-print-pdf — 1. Introduction

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### Overview and motivation
- Global economic disruption from climate change has increased interest in the macroeconomic effects of climate mitigation policies, given the net-zero target by 2050.
- So far, 97 parties, representing 101 countries and 80.7 percent of global GHG emissions, have communicated a net-zero target by around the mid-century, including China, the United States, European Union, India and Japan.
- Prior literature emphasizes impacts on economic activity, employment, international trade, distributional effects, commodity and financial markets, and monetary policy; less attention has been given to effects on current account balances and international capital flows (the external adjustment).

### Research question and model approach
- This paper examines the effect of mitigation policies on the external sector using the G-Cubed global macroeconomic model.
- Scenario studied: net-zero emissions by 2050 implemented via a package of mitigation policies:
  - (i) a carbon tax with a compensatory transfer to households,
  - (ii) a green subsidy to renewables,
  - (iii) green infrastructure investment.
- Focus: external sector impacts over the next decade; coverage includes the largest economies and aggregated regions to capture global general equilibrium effects, capital flows, and global interest rates.

### Key quantitative findings (summary)
- Combinations of climate mitigation policies can sizably impact current account balances by changing short- and medium-term investment and saving decisions.
- Carbon tax effects:
  - A credible and globally coordinated carbon tax decreases the current account in greener advanced economies and increases it in more fossil-fuel-dependent developing countries.
  - Mechanism: the tax permanently reduces the return on carbon-intensive investments → investment falls globally and more in fossil-fuel-dependent economies; adjustment costs slow expansion of non-fossil fuel sectors → initial fall in economy-wide investment.
  - Global decline in investment lowers the global interest rate, decreasing savings across countries relatively uniformly; current account movements are driven primarily by country-specific investment responses (e.g., initial carbon intensity and net fossil fuel exports).
- Supply-side policies (green subsidy and infrastructure investment):
  - These boost investment and saving and increase the global interest rate.
  - Compared with the carbon tax, they have a more limited impact on the external sector because of slow sectoral expansion for renewables (without government support) and identical-sized boosts to green infrastructure across countries, which produce comparable investment and saving responses and leave the current account broadly unchanged.
- Combined policy package:
  - The carbon tax dominates the external sector impact; other policies have much smaller effects.
  - Capital flows shift toward greener advanced economies, driven primarily by the carbon tax.
  - After an initial rise led by green infrastructure investment, the global interest rate falls over time as the increasing carbon tax reduces investment globally and shifts activity toward more labor-intensive sectors.
- Policy synchronization:
  - The current account impact depends crucially on the degree of policy synchronization across regions.
  - Partial or unilateral implementation can reverse or magnify external sector effects relative to coordinated implementation.
    - Example: a unilateral carbon tax in Europe increases Europe’s current account surplus (instead of decreasing it under coordinated implementation) because the tax reduces domestic investment and shifts capital abroad.
    - By contrast, a unilateral green subsidy in Europe magnifies the external sector response in that region by further reducing the current account as capital flows into subsidized renewable sectors.
- Current account definition used: a decrease in the current account is a move towards current account deficit while an increase is a move towards surplus.

### Links to literature
- Relation to CGE and DGE models:
  - The G-Cubed model shares features with CGE models (country and sectoral disaggregation, detailed energy sectors) but differs by incorporating DGE features: forward-looking agents, real and nominal rigidities, fiscal and monetary policies, and an endogenously determined current account (no imposed balanced current account).
- Relation to trade-environment literature:
  - Extends literature on interactions between international trade (and trade policy) and environmental pollution (and environmental policy) by considering trade imbalances/current account responses rather than only trade flows.
- Relation to global saving-investment and current account imbalance literature:
  - Climate mitigation and the green transition could induce large changes in global saving and investment, with implications for global current account balances and capital flows, akin to historical drivers of imbalances.

### Theoretical primer and analytical insights (carbon tax focus)
- A simple two-period, two-country theoretical model is developed to derive analytical insights on current account implications of carbon taxes.
- Model features and assumptions (selected):
  - Two time periods t = 1, 2; representative household with log utility and Cobb-Douglas consumption aggregator across tradable and non-tradable goods.
  - Tradable sector produces carbon emissions; non-tradable sector is non-emitting and has constant endowments.
  - Capital accumulation: K_{t+1} = K_t + I_t (depreciation set to zero).
  - Initial foreign asset position B_1 = 0.
  - Current account equation: CA_t = Y^T_t + r_t B_t − C^T_t − I_t.
  - Global financial market clears: CA_t + CA^*_t = 0, which determines the world interest rate.
- Key theoretical propositions (qualitative conclusions preserved):
  - Proposition 1: Investment function I_1(r_2) decreases in r_2; saving function S_1(r_2) increases in r_2. The monotonicity of saving follows from offsetting substitution and income effects under log utility; the wealth effect (discount channel and production resource movement) implies overall saving increases with r_2.
  - Proposition 2: Investment I_1(r_2) increases in future productivity A_2; saving S_1(r_2) decreases in A_2. When A_2 increases, channels through investment and future output offset, and the direct productivity impact on lifetime income makes current consumption rise and saving fall.
  - Carbon-tax interpretation: A carbon-tax-induced negative future productivity shock (ΔA_2 < 0) shifts I_1(r_2) left and S_1(r_2) right in a Metzler diagram; equilibrium world interest rate unambiguously falls and capital flows from the Home economy to the Foreign economy (Home runs a current account surplus).
  - Proposition 3: Domestic non-tradable price p_1 increases in A_2; foreign non-tradable price p^*_1 also increases in A_2. A fall in future productivity lowers tradable output and, via both productivity and interest rate channels, makes non-tradables cheaper domestically and abroad (interest-rate channel common across economies).
  - Proposition 4: The real exchange rate e_1 = p_1 / p^*_1 in the Home economy depreciates in response to a carbon-tax-driven negative future productivity shock (ΔA_2).
- Numerical note for the Metzler diagram example:
  - This figure is based on α=0.3, β=0.9, K1=1, A1=A2=1 and ΔA2=−0.3.

### Implications and need for quantitative general equilibrium
- The theoretical section shows that carbon taxes (proxied by future productivity declines) can induce external sector adjustments: countries facing larger future carbon taxes will run current account surpluses and experience currency depreciation; global interest rates fall.
- Limitations of the simple model motivating G-Cubed:
  - Does not robustly pin down magnitudes of equilibrium investment and saving.
  - Omits the green transition–induced shift away from relatively capital-intensive energy sectors.
  - Does not capture cross-country heterogeneity in carbon intensity of economic activity.
- The G-Cubed global quantitative general equilibrium model is used in subsequent sections to quantify these effects over the next decade.

*Source: wpiea2024162-print-pdf — 1. Introduction*

### 1. Introduction

### 1. Introduction

### Overview and motivation
- Global economic disruption from climate change has increased interest in the macroeconomic effects of climate mitigation policies, given the net-zero target by 2050.
- So far, 97 parties, representing 101 countries and 80.7% of global GHG emissions, have communicated a net-zero target by around the mid-century, including the largest emitters, such as China, the United States, European Union, India and Japan.
- Prior literature focuses on impacts of mitigation policies on economic activity, employment, international trade, distributional effects, commodity and financial markets, and monetary policy; less attention has been given to effects on current account balances and international capital flows (the external adjustment).

### Research question and model approach
- This paper examines the effect of mitigation policies on the external sector using the G-Cubed global macroeconomic model.
- Scenario studied: net-zero emissions by 2050 implemented via a package of mitigation policies:
  - (i) a carbon tax with a compensatory transfer to households,
  - (ii) a green subsidy to renewables,
  - (iii) green infrastructure investment.
- Focus: external sector impacts over the next decade; coverage includes the largest economies and aggregated regions to capture global general equilibrium effects, capital flows, and global interest rates.

### Key quantitative findings (summary)
- Combinations of climate mitigation policies can sizably impact current account balances by changing short- and medium-term investment and saving decisions.
- Carbon tax effects:
  - A credible and globally coordinated carbon tax decreases the current account in greener advanced economies and increases it in more fossil-fuel-dependent developing countries.
  - Mechanism: the tax permanently reduces the return on carbon-intensive investments → investment falls globally and more in fossil-fuel-dependent economies; adjustment costs slow expansion of non-fossil fuel sectors → initial fall in economy-wide investment.
  - Global decline in investment lowers the global interest rate, decreasing savings across countries relatively uniformly; current account movements are driven primarily by country-specific investment responses (e.g., initial carbon intensity and net fossil fuel exports).
- Supply-side policies (green subsidy and infrastructure investment):
  - These boost investment and saving and increase the global interest rate.
  - Compared with the carbon tax, they have a more limited impact on the external sector because of slow sectoral expansion for renewables (without government support) and identical-sized boosts to green infrastructure across countries, which produce comparable investment and saving responses and leave the current account broadly unchanged.
- Combined policy package:
  - The carbon tax dominates the external sector impact; other policies have much smaller effects.
  - Capital flows shift toward greener advanced economies, driven primarily by the carbon tax.
  - After an initial rise led by green infrastructure investment, the global interest rate falls over time as the increasing carbon tax reduces investment globally and shifts activity toward more labor-intensive sectors.
- Policy synchronization:
  - The current account impact depends crucially on the degree of policy synchronization across regions.
  - Partial or unilateral implementation can reverse or magnify external sector effects relative to coordinated implementation.
    - Example: a unilateral carbon tax in Europe increases Europe’s current account surplus (instead of decreasing it under coordinated implementation) because the tax reduces domestic investment and shifts capital abroad.
    - By contrast, a unilateral green subsidy in Europe magnifies the external sector response in that region by further reducing the current account as capital flows into subsidized renewable sectors.
- Current account definition used: a decrease in the current account is a move towards current account deficit while an increase is a move towards surplus.

### Links to literature
- Relation to CGE and DGE models:
  - The G-Cubed model shares features with CGE models (country and sectoral disaggregation, detailed energy sectors) but differs by incorporating DGE features: forward-looking agents, real and nominal rigidities, fiscal and monetary policies, and an endogenously determined current account (no imposed balanced current account).
- Relation to trade-environment literature:
  - Extends literature on interactions between international trade (and trade policy) and environmental pollution (and environmental policy) by considering trade imbalances/current account responses rather than only trade flows.
- Relation to global saving-investment and current account imbalance literature:
  - Climate mitigation and the green transition could induce large changes in global saving and investment, with implications for global current account balances and capital flows, akin to historical drivers of imbalances.

### Theoretical primer and analytical insights (carbon tax focus)
- A simple two-period, two-country theoretical model is developed to derive analytical insights on current account implications of carbon taxes.
- Model features and assumptions (selected):
  - Two time periods t = 1, 2; representative household with log utility and Cobb-Douglas consumption aggregator across tradable and non-tradable goods.
  - Tradable sector produces carbon emissions; non-tradable sector is non-emitting and has constant endowments.
  - Capital accumulation: K_{t+1} = K_t + I_t (depreciation set to zero).
  - Initial foreign asset position B_1 = 0.
  - Current account equation: CA_t = Y^T_t + r_t B_t − C^T_t − I_t.
  - Global financial market clears: CA_t + CA^*_t = 0, which determines the world interest rate.
- Key theoretical propositions (qualitative conclusions preserved):
  - Proposition 1: Investment function I_1(r_2) decreases in r_2; saving function S_1(r_2) increases in r_2. The monotonicity of saving follows from offsetting substitution and income effects under log utility; the wealth effect (discount channel and production resource movement) implies overall saving increases with r_2.
  - Proposition 2: Investment I_1(r_2) increases in future productivity A_2; saving S_1(r_2) decreases in A_2. When A_2 increases, channels through investment and future output offset, and the direct productivity impact on lifetime income makes current consumption rise and saving fall.
  - Carbon-tax interpretation: A carbon-tax-induced negative future productivity shock (ΔA_2 < 0) shifts I_1(r_2) left and S_1(r_2) right in a Metzler diagram; equilibrium world interest rate unambiguously falls and capital flows from the Home economy to the Foreign economy (Home runs a current account surplus).
  - Proposition 3: Domestic non-tradable price p_1 increases in A_2; foreign non-tradable price p^*_1 also increases in A_2. A fall in future productivity lowers tradable output and, via both productivity and interest rate channels, makes non-tradables cheaper domestically and abroad (interest-rate channel common across economies).
  - Proposition 4: The real exchange rate e_1 = p_1 / p^*_1 in the Home economy depreciates in response to a carbon-tax-driven negative future productivity shock (ΔA_2).
- Numerical note for the Metzler diagram example:
  - This figure is based on α=0.3, β=0.9, K1=1, A1=A2=1 and ΔA2=−0.3.

### Implications and need for quantitative general equilibrium
- The theoretical section shows that carbon taxes (proxied by future productivity declines) can induce external sector adjustments: countries facing larger future carbon taxes will run current account surpluses and experience currency depreciation; global interest rates fall.
- However, the simple model does not robustly pin down equilibrium investment and saving magnitudes or fully capture features such as:
  - The green transition–induced shift away from relatively capital-intensive energy sectors.
  - Cross-country heterogeneity in carbon intensity of economic activity.
- A full-fledged quantitative global general equilibrium model (G-Cubed) is required to quantify these effects, which the paper provides in subsequent sections.

*Content unit: wpiea2024162-print-pdf — 1. Introduction*

### 3. A Quantitative Model

### 3. A Quantitative Model

### 3.1 The G-Cubed Model
- Model partitioning and sectors:
  - Partitions the world economy into 10 countries and regions: AUS (Australia), CHN (China), EUW (Europe), IND (India), JPN (Japan), OPC (Selected Oil-Exporting Developing Countries), OEC (Rest of the OECD), ROW (Rest of the World), RUS (Russian Federation), USA (United States).
  - Includes 20 sectors, with detailed energy and power generation sectors, including three fossil fuel sectors—oil, gas, and coal—and renewables-based electricity generation sectors.
- Sector list (numbered as in source):
  - 1 Electricity delivery; 2 Gas extraction and utilities; 3 Petroleum refining; 4 Coal mining; 5 Crude oil extraction; 6 Construction; 7 Other mining; 8 Agriculture and forestry; 9 Durable goods; 10 Nondurable goods; 11 Transportation; 12 Services; 13 Coal generation; 14 Natural gas generation; 15 Petroleum generation; 16 Nuclear generation; 17 Wind generation; 18 Solar generation; 19 Hydroelectric generation; 20 Other generation.
- Key structural asymmetries captured:
  - Carbon intensity differs across regions; higher in China and India due to heavier reliance on coal.
  - Renewables output concentrated in Europe, which accounts for 62 percent of global renewable energy (including solar, wind, and other renewables).
  - Renewables account for about 20 percent of energy generation in Europe and the OEC; represent less than 5 percent in all fossil fuel exporters.
  - Energy trade differs: Russia and the OPC group are main fossil fuel exporters; some countries (e.g., Japan) are fossil fuel importers, especially of oil and gas.
- Model features:
  - Intertemporal general equilibrium with standard optimization.
  - Rigidities: limits on the pace of investment via quadratic adjustment costs.
  - Cross-border capital and trade flows and bilateral cross-border input linkages.
  - Heterogeneous households and firms: a fraction of households consume current income; a fraction of firms make backward-looking investment decisions.
  - Monetary and fiscal policy rules.
  - Full external sector: intertemporal decisions determine saving and investment; the gap between aggregate saving and investment determines the current account.
  - Real interest rate affects saving, investment, and human wealth through discounting.
  - Flexible exchange rates and open capital accounts assumed for the 10 countries and regions.
- Note: The precautionary saving motive is absent from the model.

### 3.2 The Baseline Scenario
- Key inputs and calibration:
  - Baseline relies on projections of population, sectoral productivity growth rates by sector and country, and projections of energy efficiency improvements.
  - Model solved from 2018, adjusted to replicate the 2018 database; initial dynamics from 2018 to 2019 used.
  - Sectoral output growth from 2018 onwards driven by labor force growth and labor productivity growth.
- Labor and productivity assumptions:
  - Labor force: working-age population projections from the UN Population Prospects 2019 calculate economy-wide labor growth rates for each region.
  - United States assumed as world productivity frontier in each sector; US productivity increases at a constant rate of 1.4 percent every year for all sectors except renewables.
  - Renewable sectors in the US assumed to grow more quickly at an additional rate of 5 percent (6.4 percent in total).
  - Other economies follow a Barro catch-up approach: average catchup rate to the worldwide productivity frontier is 2% per year.
  - Initial productivity levels from the Groningen Growth and Development database; catchup rates varied over time to mirror expected reform or rigidity.
- Energy efficiency assumptions:
  - Autonomous energy efficiency increases at a constant rate of 1 percent every year for all economies except China and India.
  - For China and India, an additional rate of 2 percent is assumed (3 percent in total).
- Covid-19 treatment:
  - Baseline abstracts from the 2020 pandemic-related fall in output and emissions, assuming rebound brings 2021 levels close to 2018 levels.
- Baseline projections:
  - Global carbon emissions continue rising at an average annual pace of 1.7 percent and reach 57.5 gigatons by 2050.
  - Global growth progressively declines from 3.7 percent in 2021 to 2.1 percent in 2050.
  - China and India remain significant emitters and account for growing shares of carbon emissions, though their per capita emissions remain relatively small compared with advanced economies.

### 3.3 Climate Change Mitigation Scenario
- Objective and policy package:
  - Brings global net carbon emissions to zero by 2050 using a package of carbon taxes, compensatory transfers to households, and green supply policies (infrastructure investment and a subsidy to renewables).
- Carbon tax design:
  - Carbon prices calibrated to achieve an 80 percent reduction in emissions from the energy sector in each region by 2050 relative to 2018, after accounting for emission reductions from infrastructure investment and the green subsidy.
  - The carbon tax consists of an initial tax rate followed by an annual increase of 7 percent.
  - Revenue recycling: one quarter of carbon tax revenues are transferred back to households to protect the poorest households; three-quarters of revenue recycled to reduce government debt.
- Green subsidy:
  - Subsidy to output of renewables—solar and wind electricity sectors—financed by government debt.
  - Output of renewables receives a price subsidy of 80 percent.
- Low-carbon infrastructure investment:
  - Initial green public infrastructure investment of 1 percent of GDP gradually declines to zero over 10 years.
  - Public investment targets renewables and other low-carbon energy sectors, transport infrastructure, and services.
  - Calibration: for every 10 percent increase in the aggregate stock of infrastructure capital, productivity in private sector output rises by 0.8 percent.
  - To sustain new infrastructure, an additional 0.2 percent of GDP is spent to offset depreciation and lock in productivity gains.
- Emission accounting and exceptions:
  - The carbon tax by 2050 accounts for 80 percent of emission reductions; the remaining 20 percent of carbon emission reductions come from factors not captured by the model (natural emission sinks and carbon removal technologies).
  - Exception: OPC region emissions are kept at the initial level because of an outsized negative economic impact from the global decline in demand for fossil fuels.
- Roles and dynamics of the policies:
  - Carbon tax: primary channel for emission reductions but negatively impacts economic growth and reduces energy usage; shifts economic activity from capital-intensive high-carbon sectors to labor-intensive low-carbon sectors, making the impact more negative for investment than for output and employment.
  - Green supply-side policies (infrastructure and subsidies): provide limited contributions to emission reductions but ensure the green transition is growth neutral at the global level.
  - The shift to renewables is slow due to limits on the pace of sectoral expansion; targeted policies can facilitate sector growth.
  - Credibility and anticipation of mitigation policies are crucial; credible carbon tax policy can generate large immediate investment and dynamic effects even if initially small.
- Additional scenario features:
  - Transition is gradual and orderly, avoiding abrupt adjustments in fossil fuel prices, which increase persistently over the scenario’s horizon.
  - No technological breakthroughs or leapfrogging are assumed beyond spillovers from green infrastructure investment.
  - Results abstract from long-term climate damages; a model extension suggests very limited economic and external sector impact over the next decade.

*IMF Working Paper — Chapter 3: A Quantitative Model*

### 4.1 Carbon Tax

### 4.1 Carbon Tax

### Overview
- The carbon tax policy is modeled as a negative productivity shock varying by sector and country, with tax levels gradually increasing until 2050 to achieve emission targets.
- Greener countries are the least affected; fossil fuel extraction activities are permanently reduced.
- Results are reported as average deviations from the baseline growth path for the first 10 years of the simulation.

### Global macroeconomic effects
- Aggregate investment decreases globally as the anticipated return on fossil-fuel-linked investment is permanently reduced.
- Investment and saving decline by 2 percent of global GDP over the first decade.
- The global interest rate declines by 0.25 percentage point (or 25 basis points).
- The adjustment is back-loaded in policy design but economically sizable due to the high capital intensity of fossil-fuel-dependent activity.

### Cross-country investment and saving responses
- Declines in investment relative to baseline depend on the share of fossil-fuel-related investment in total investment (or the share of fossil-fuel-related output in total output).
- Investment contraction is most pronounced in fossil-fuel-producing countries and regions (Russia, OEC, ROW, OPC) and least pronounced in relatively greener advanced economies and regions (Japan, EUW).
- China and India are more negatively affected than advanced economies because of carbon-intensive manufacturing activities.
- Saving declines in all countries but with more homogeneous cross-country responses compared to investment.
  - Two channels affect saving: (i) lower investment reduces total wealth and thus saving; (ii) lower real interest rates increase saving. The overall effect is dominated by the wealth effect.
- Public sector surpluses from carbon tax revenues are more than offset by private dissaving, resulting in decreased aggregate saving.

### Current account, capital flows, and real exchange rate (RER)
- The current account response is driven by heterogeneity in the investment response across countries:
  - The current account decreases where investment contracts the least and increases where the carbon tax decreases investment the most, as capital is relocated towards greener economies.
  - Cross-country correlation between investment and current account responses: –0.94.
  - Correlation between current account and aggregate saving responses: 0.01 (absence of correlation).
- The RER acts as a shock absorber:
  - RER depreciates in countries with the most negative economic impact (largest declines in investment and capital outflows), facilitating expenditure switching (domestic demand shifts from imports to domestic goods; exports boosted).
  - Countries least affected show capital inflows and current account deficits relative to baseline.
  - Cross-country correlation between current account and RER responses: –0.86.
- Real interest rate heterogeneity:
  - Governed by the change in investment relative to saving within each economy.
  - Countries with larger falls in investment relative to saving experience larger falls in the real interest rate.
  - Responses in real interest rates are highly correlated with investment responses across countries.

### Magnitude of external sector impacts (first-decade averages)
- Absolute value of 10-year average current account response ranges from 0.3 to 3 percent of GDP.
- Absolute value of RER adjustments, relative to baseline, ranges from 0 to 4.8 percent, with an outsized response in initial years.

### Drivers of cross-country heterogeneity
- Initial carbon intensity is a key determinant of differential external sector responses.
- Higher projected labor force and productivity growth rates and sectors with limited scope to reduce carbon reliance imply higher long-run carbon emissions and thus higher required carbon taxes to reach 2050 targets.
- Collected carbon tax revenues exhibit a strong positive correlation with the change in the current account:
  - Regions with the highest tax revenues (and projected carbon emissions) see the largest increases in their current account (a form of twin surpluses).
  - Regions with relatively low carbon tax revenues exhibit current account decreases.
- Net fossil-fuel-exporter status is an additional determinant:
  - Net fossil-fuel-exporting countries face reduced foreign demand for fossil fuels, further depressing investment and increasing the current account.
  - This effect operates even if the fossil-fuel-exporting country does not impose a carbon tax.
- The G-Cubed model used does not incorporate sufficient detail on mineral resources to assess potential surges in demand for metals critical for the green energy transition.

*IMF Working Paper excerpt (4.1 Carbon Tax).*

### 4.5 Role of Policy Synchronization

### 4.5 Role of Policy Synchronization

### Asynchronous implementation and global aggregates
- Partial or asynchronous implementation of mitigation policies introduces policy asymmetry that alters external sector outcomes.
- The baseline analysis assumes globally coordinated implementation with all countries reaching emission reduction targets; progress and medium-term commitments toward climate change mitigation vary considerably across countries.
- A partial implementation scenario is examined where only one region—Europe—implements the carbon tax and the green subsidy.

- Global effects of a unilateral European carbon tax:
  - Fall in investment and saving globally with a reduction in the global interest rate, but the size of the adjustment is significantly smaller than under coordinated implementation.
  - A mere 0.2 percent of GDP drop in investment (and saving) globally over the first decade.
  - A 0.02 percentage point decrease in the interest rate over the first decade.

### Heterogeneous regional spillovers from a unilateral carbon tax
- Europe:
  - The carbon tax reduces the anticipated return on investment in Europe, causing investment and saving to fall in that region.
  - Relative to coordinated implementation, the fall in investment in Europe is magnified because the carbon tax is accommodated by a smaller decline in the global interest rate.
  - The outsized fall in investment increases the current account in Europe (instead of decreasing under coordinated implementation).
  - Europe becomes a source of capital outflows as investment shifts toward regions with a higher return on investment.

- Fossil-fuel-exporting countries (e.g., Russia and OPC group):
  - Spillovers from reduced demand for fossil fuels in Europe depress investment upstream in Europe’s fossil-fuel-supplying countries.
  - These countries experience sizable negative economic impacts and current account surpluses (reflecting capital flows out of Europe and its fossil-fuel suppliers).

- Other regions/countries that do not impose the carbon tax:
  - Investment increases marginally, while saving declines (as in Europe).
  - These regions run current account deficits as capital flows in from Europe and its suppliers.

- Net competitiveness effect:
  - A unilateral carbon tax in Europe reveals a sizable negative competitiveness impact for Europe relative to coordinated implementation.
  - The current account response is reversed for Europe: instead of drawing capital inflows, Europe experiences capital outflows.

### Heterogeneous regional spillovers from a unilateral green subsidy
- Europe-only green subsidy:
  - Further boosts economic activity in Europe; results resemble coordinated implementation given Europe’s outsized role in the global green subsidy.
  - The subsidy only in Europe raises the global interest rate by less than coordinated implementation, so the interest rate effect is more muted.
  - Investment in Europe is boosted, further decreasing the region’s current account.

- Other countries/regions:
  - External sector outcomes reflect a trade-off between the green subsidy and a more muted increase in the global interest rate.
  - Where the subsidy under coordinated implementation is small (Russia, OPC), the interest rate effect dominates—investment increases and the current account balance is reduced.
  - Where the subsidy is more sizable (United States, Japan), the absence of the subsidy dominates—investment is reduced and the current account increases.

### Broader implications of partial implementation
- Partial implementation of mitigation policies can have sizable and varied impacts on the external sector, either putting countries at a competitive disadvantage or magnifying the economic boost from a mitigation policy.
- A critical shortcoming of partial implementation is the failure to deliver the necessary global carbon emission reductions.
- To avert climate change, both advanced and developing countries must cooperate in achieving climate mitigation targets, including through burden-sharing arrangements such as income-differentiated carbon price floors or sectoral carbon pricing.

*Source: wpiea2024162-print-pdf - 4.5 Role of Policy Synchronization*

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_Source: https://www.imf.org/-/media/files/publications/wp/2024/english/wpiea2024162-print-pdf.pdf_