## Annex I. Current EU Policies to Reduce Emissions

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---

### Introduction and framing
- EU targets and policy context:
  - “Fit for 55” agenda: reduce EU emissions by 55 percent below 1990 levels by 2030 (Annex 1).
  - Provisional binding 90 percent cut by 2040 (vis-à-vis 1990); European Council endorsed interim 2035 target range of 66.25–72.5 percent.
- Literature tension and conceptual gap:
  - “Bottom-up” studies: aggregate green investment effects often exceed 2 and even 3 percent of GDP annually over the next ten to fifteen years.
  - “Top-down” studies: find negligible or negative aggregate investment impacts.
  - Gap: bottom-up studies capture sectoral technology detail but miss general equilibrium substitution and demand effects; top-down models capture general equilibrium but often lack detailed sectoral representation of abatement investments.

### Main quantitative findings and projections
- Green and aggregate investment impacts (central policy mix combining carbon pricing, green subsidies, and labor tax cuts):
  - Increase in green investment: around 1.6 percentage points of GDP annually at its peak.
  - Average green investment increase during 2026-2035: 1.3 percentage points of GDP (2.2 trillion euros in cumulative terms).
  - Aggregate investment rises by just 1.2 percentage points of GDP at its peak and about 1 percentage point of GDP on average (partial substitution of brown for green investment).
  - About one-third of additional green investment is offset by declines in brown investment.
- Carbon pricing and revenues:
  - Carbon prices rise by about $200 per ton (real terms) by 2030 and continue to rise thereafter in simulations to meet targets.
  - Additional ETS1 and ETS2 revenue could reach about 1 percent of GDP by 2035 (a quadrupling relative to current levels).
  - ETS revenue in 2023 was around ¼ percent of EU GDP.
- Emissions targets and baseline assumptions:
  - Simulation 2035 target: a 69 percent emissions reduction below 1990 levels (illustrative midpoint of 2035 NDC range).
  - This 69 percent reduction corresponds to a 44 percent reduction of emissions relative to the projected baseline in 2035.
  - Baseline assumptions: ETS1 cap frozen at 2024 levels; heating baseline emissions decline 23 percent during 2026-35 (linear extrapolation of prior 10 years); transport baseline emissions decline 23 percent between 2025 and 2035.
- Sectoral composition of investment responses:
  - Renewables investment: roughly quadruples relative to baseline in central scenario.
  - Building insulation investment: roughly doubles.
  - Energy-efficient capital in energy-intensive tradable sectors rises by over 50 percent above baseline.
  - EV share rises about 15 percentage points above baseline by 2030 and over 30 percentage points by 2035 (EV purchases treated as durable consumption rather than investment in national accounts).

### Model and methodology (GMMET extensions)
- Model class and novel features:
  - Extended GMMET: a multi-country New Keynesian model with detailed energy and sectoral structure, blending general equilibrium macro modeling with bottom-up sector calibration.
  - Macro core: based on GIMF (Kumhof and others, 2010), featuring OLG households (non-Ricardian fiscal dynamics), inflation-forecast-based monetary policy, nominal rigidities, and real adjustment costs for investment and hiring.
  - Sectoral detail: explicit modeling of power (wind, solar, hydro, nuclear, fossil), fossil-fuel mining, transport (ICE vs EV, network externalities), heating (gas furnaces vs heat pumps, building insulation), energy-intensive and regular tradables, and energy inputs into intermediate and final demand.
  - Policy instruments: carbon pricing across modeled sectors, phase-out of free ETS1 allowances over 2026-2034, ETS2 introduced in 2028 (fully anticipated), CBAM modeled as a charge on energy-intensive tradable imports (scope 1 and selected scope 2/3), and flexible revenue recycling options (subsidies, labor/capital/consumption tax cuts, lump-sum rebates).
- Calibration and linkage to bottom-up evidence:
  - Sector-specific investment needs for abatement are calibrated to be consistent with bottom-up studies (e.g., costs of electrification, heating and insulation, EII abatement).
  - The model captures need for renewables backup and electricity grid considerations; interconnector/grid-specific investment not explicitly modeled but estimated to have small aggregate impact in simulations.
- Energy-efficiency capital and heating sector calibration:
  - Elasticity of substitution between energy and energy-efficiency capital set to 1.7.
  - Resulting shares: about a quarter of capital stock is energy-efficiency capital for the energy-intensive tradable goods sector and about half that share for the general tradable goods sector.
  - Heating calibration target: about €60 per ppt reduction in sectoral emissions (calibration choice between EC and IEA implied figures).

### Policy scenarios and sensitivity to revenue recycling
- Three main scenarios (identical emission targets; differ by revenue recycling):
  1. Central scenario: Two-thirds of carbon pricing revenues to “green subsidies” and one-third to labor tax cuts.
     - Two-thirds of subsidies allocated to renewable energy capital; remaining third split equally among EVs, insulation, and electricity-based heating (heat pumps).
  2. Labor-tax-cut scenario: All carbon pricing revenues used to cut labor taxation (no subsidies).
  3. Lump-sum transfer scenario: All revenues rebated to households as lump-sum transfers (no subsidies or tax cuts).
- Key scenario comparisons and quantitative effects:
  - Central scenario:
    - Peak green investment: ~1.6 percentage points of GDP; annual average 1.3 percentage points of GDP during 2026-2035.
    - Peak aggregate investment: ~1.2 percentage points of GDP; net GDP increases by almost 0.2 percent on a net basis; exports fall by 2.5 percent (real exchange rate appreciation).
    - Electricity prices: rise by about 5 percent above baseline by 2035 (about 0.5 percent per year).
    - Inflation and interest rate dynamics: headline and core inflation initially fall; monetary policy eases slightly early on then becomes slightly restrictive later in the horizon.
  - Labor-tax-cut (no subsidies) scenario:
    - Peak green investment: ~1.2 percentage points of GDP (about 0.3 percentage points lower than central).
    - Peak aggregate investment: ~0.9 percentage points of GDP (about 0.3 percentage points lower than central).
    - Required carbon prices to meet targets are about $50 higher than in the central scenario.
    - Real GDP marginally weaker and inflation a bit higher than central, but households’ consumption rises materially due to larger labor tax cuts.
  - Lump-sum transfer scenario:
    - Performs more poorly than the central scenario on GDP and energy prices (fails to boost renewables capacity and does not stimulate labor supply).
- Mechanisms:
  - Green subsidies lower the carbon price needed to meet targets and support larger renewables deployment, helping contain electricity price increases.
  - Labor tax cuts stimulate labor supply and consumption, supporting household incomes and GDP.
  - Lump-sum rebates lack allocative incentives, leading to higher carbon prices and weaker investment outcomes.

### Fiscal and public vs private investment implications
- Illustrative public financing assumptions:
  - Assumed public share of aggregate investment needs: illustrative 40 percent.
  - Under a 40/60 public/private split, peak increase in public investment implied by model scenarios:
    - Up to 0.4 percentage points of GDP on average (0.5 percentage points of GDP at peak) in central scenario variants that rely more on subsidies.
    - In a scenario with full recycling into lump-sum transfers and a peak aggregate investment impact of about 0.9 percent of GDP, a 40 percent public share implies a peak public investment increase of about 0.4 percent of GDP (0.3 percent on average over 2026-2035).
  - These public financing needs would be about half of projected ETS1 and ETS2 revenues (projected carbon pricing revenues could reach about 1 percent of GDP).
- Range in the literature on public share:
  - Published estimates vary from about 17 percent to 60 percent public share depending on methodology and sectoral assumptions.
  - Pisani-Ferry and Tagliapietra (2024) suggest public contribution may range from 25 to 50 percent.
- Sectors with greatest public financing needs:
  - Rail, public transport, and buildings typically require higher public funding shares (examples: up to 90-95 percent public coverage for rail/public transport gaps in a high-public scenario; 45 percent public share for buildings in a balanced mix).
- Role of EU budgetary instruments:
  - EU programs and funds (MFF 2021-27, Next Generation EU, Recovery and Resilience Facility) already provide significant public funding for the green transition via grants, subsidies, tax credits, and guarantee/risk-sharing instruments.

### Robustness, limitations, and interpretation
- Model strengths:
  - Bridges bottom-up sectoral investment detail with top-down general equilibrium dynamics, producing intermediate estimates (e.g., around EUR 400 per abated tCO2e in GMMET versus ~EUR 500 in many bottom-up studies and much lower in many top-down studies).
  - Captures sectoral investment specificity (buildings, transport, renewables, energy-intensive manufacturing) while retaining macro feedbacks.
- Limitations and caveats:
  - Some mitigation measures and sectors are not modeled in detail (e.g., certain ETS1/ETS2 measures like car emission regulations; agriculture and non-CO2 gases not modeled).
  - Some investment needs (e.g., specific interconnectors, grid expansion) are not explicitly modeled; authors argue impacts on aggregate investment are likely small within their scenarios.
  - The model does not capture certain dynamic benefits such as R&D-driven technological progress or long-run cost declines from scale and learning-by-doing beyond what is parameterized.
  - Results depend critically on assumptions about revenue recycling, phasing out free allowances, ETS2 introduction timing (assumed 2028), and slotting of sectoral 2035 ETS targets (assumptions: 2035 ETS1 target = 47 percent reduction below baseline; ETS2 = 40 percent below baseline, given ETS2 reduction pace twice that of ETS1 between 2030 and 2035).

### Conclusions and policy implications
- Aggregate investment cost:
  - Granular GE modeling implies an average aggregate investment cost of around 1 percent of GDP over the coming decade, with a peak of about 1.2 percent of GDP.
- Macroeconomic implications under an illustrative policy mix (carbon pricing + green subsidies + labor tax cuts):
  - Modest implications for GDP, consumption, electricity prices, and inflation.
  - Smart revenue recycling (green subsidies and labor tax cuts) materially improves macroeconomic outcomes relative to lump-sum rebates by containing energy prices, supporting investment, and stimulating labor supply.
- Policy trade-offs and recommended complements:
  - Use carbon pricing revenues to address market failures and reduce distortions (subsidies for deployment/innovation and cuts to labor taxation) while recognizing trade-offs across growth, energy price containment, energy security, fiscal consolidation, and income distribution objectives.
  - Complementary measures: reduce policy uncertainty to incentivize early investment; fund European energy-related public goods (e.g., inter-connectors); consider carbon price floors or corridors; coordinate industrial policy to reduce subsidy-race risks.
  - Fiscal arrangements: accommodate spending on EU public goods related to the energy transition in the EU’s multiannual financial framework or through joint spending by some or all member states.
  - Structural and financial-sector complements: simpler and stronger taxonomy of green investment products; streamline permitting and planning for renewables; invest in skills to smooth worker reallocation; deepen the capital markets union to facilitate access to finance for green investment and capital reallocation.

### Current EU climate strategy, targets, and sectoral policies (summary)
- Overarching commitment:
  - Climate neutrality by 2050 (legally binding).
  - Interim targets for 2030, 2035, 2040.
- Specific targets and legal status:
  - 2030: ≥55 percent reduction vs. 1990 — Yes (legally binding; enshrined in EU Climate Law; part of Fit-for-55 package).
  - 2035: 66.25–72.5 percent reduction vs. 1990 — No (not legally binding; supported in Fall 2025 as interim range).
  - 2040: 90 percent reduction vs. 1990 (including up to 5 percent through carbon credits) — Yes (amended EU Climate Law cleared trilogue stage).
  - 2050: Climate neutrality — Yes (legally binding under EU Climate Law; net-zero GHG emissions).
- Selected sectoral policies and targets:
  - EU ETS1: Objective: 62 percent emissions reduction by 2030 relative to 2005 levels; LRF set at 4.3 percent for 2024-2027 and 4.4 percent from 2028 onward; two one-off rebasing reductions agreed (2024 and 2026); maritime transport added to ETS1.
  - EU ETS2: Objective: 42 percent emission reduction by 2030 relative to 2005 levels; planned implementation starting from 2028; Market Stability Reserve aimed to keep allowances near €45–55 per ton of CO₂.
  - RED III: Target: 42.5 percent share of renewables in final energy consumption by 2030 with an aspirational goal of 45 percent.
  - EED: Target: 11.7 percent reduction in final energy consumption relative to 2020 EU reference scenario projection for 2030.
  - ESR: Target: 40 percent emissions reduction relative to 2005 levels by 2030.
  - LULUCF Regulation: Target: 310 Mt CO₂-eq net removals across the EU by 2030.
  - CO₂ Standards for Cars and Vans: Target: 100 percent reduction in new car and van CO₂ emissions by 2035 — EC proposed to reduce to 90 percent in December 2025.
  - EPBD: Target: All new buildings zero-emission by 2030; public buildings by 2028.
  - ReFuelEU: Target: Minimum SAF of 2 percent by 2025 rising to 70 percent by 2050; Minimum Synthetic Fuel Share rising from 1.2 percent in 2030 to 35 percent in 2050.
- Multi-layered policy design:
  - Example: buildings covered by ETS2, EED, ESR, EPBD; road transport covered by ETS2 and CO2 standards including the 2035 ICE car ban; regulations complement carbon pricing where pricing alone may not send clear enough signals for long-horizon investments.

*Source: IMF WORKING PAPERS — The EU’s Energy Transition: Investment Impact and Role of Carbon Pricing Revenue Recycling (Annex I content from the provided PDF).*

### Annex I. Current EU Policies to Reduce Emissions .......................................................................

### Annex I. Current EU Policies to Reduce Emissions

### Annex overview
- Title: Annex I. Current EU Policies to Reduce Emissions
- Location in source: page 26

### Adjacent annex listing (from source table of contents)
- Annex II. An Extension of the GMMET Model and its Calibration — page 28

*Source: wpiea2026046-source-pdf - Annex I. Current EU Policies to Reduce Emissions (page references as listed in the source).*

### References .............................................................................................................

### The EU’s Energy Transition: Investment Impact and Role of Carbon Pricing Revenue Recycling

### Introduction and framing
- EU targets and policy context:
  - “Fit for 55” agenda: reduce EU emissions by 55 percent below 1990 levels by 2030 (Annex 1).
  - Provisional binding 90 percent cut by 2040 (vis-à-vis 1990); European Council endorsed interim 2035 target range of 66.25–72.5 percent.
- Tension in the literature:
  - “Bottom-up” studies: aggregate green investment effects often exceed 2 and even 3 percent of GDP annually over the next ten to fifteen years (Calipel and others, 2025; IRENA, 2025; Pisani-Ferry and Mahfouz, 2023).
  - “Top-down” studies: find negligible or negative aggregate investment impacts (e.g. Coenen and others, 2024).
  - Key conceptual gap: bottom-up studies capture sectoral technology detail but miss general equilibrium substitution and demand effects; top-down models capture general equilibrium but often lack detailed sectoral representation of abatement investments.

### Main quantitative findings and projections
- Green and aggregate investment impacts (central policy mix combining carbon pricing, green subsidies, and labor tax cuts):
  - Increase in green investment: around 1.6 percentage points of GDP annually at its peak.
  - Average green investment increase during 2026-2035: 1.3 percentage points of GDP (2.2 trillion euros in cumulative terms).
  - Aggregate investment rises by just 1.2 percentage points of GDP at its peak and about 1 percentage point of GDP on average (due to partial substitution of brown for green investment).
  - These results lie between typical bottom-up and top-down estimates: below many bottom-up totals (which omit general equilibrium offsets) and above most top-down estimates (which under-represent sectoral green investment needs).
- Carbon pricing and revenues:
  - Carbon prices rise by about $200 per ton (real terms) by 2030 and continue to rise thereafter in simulations to meet targets.
  - Additional ETS1 and ETS2 revenue could reach about 1 percent of GDP by 2035 (a quadrupling relative to current levels).
  - ETS revenue in 2023 was around ¼ percent of EU GDP.
- Emissions targets and baseline assumptions:
  - Simulation 2035 target: a 69 percent emissions reduction below 1990 levels (illustrative midpoint of 2035 NDC range).
  - This 69 percent reduction corresponds to a 44 percent reduction of emissions relative to the projected baseline in 2035.
  - Baseline assumptions: ETS1 cap frozen at 2024 levels (ETS1 baseline emissions unchanged over 2026-2035); heating baseline emissions decline 23 percent during 2026-35 (linear extrapolation of prior 10 years); transport baseline emissions decline 23 percent between 2025 and 2035.
- Sectoral composition of investment responses:
  - Renewables investment: roughly quadruples relative to baseline in central scenario.
  - Building insulation investment: roughly doubles.
  - Energy-efficient capital in energy-intensive tradable sectors rises by over 50 percent above baseline.
  - EV share rises about 15 percentage points above baseline by 2030 and over 30 percentage points by 2035 (EV purchases treated as durable consumption rather than investment in national accounts).

### Model and methodology (GMMET extensions)
- Model class and novel features:
  - Extended GMMET: a multi-country New Keynesian model with detailed energy and sectoral structure, blending general equilibrium macro modeling with bottom-up sector calibration.
  - Macro core: based on GIMF (Kumhof and others, 2010), featuring OLG households (non-Ricardian fiscal dynamics), inflation-forecast-based monetary policy, nominal rigidities, and real adjustment costs for investment and hiring.
  - Sectoral detail: explicit modeling of power (wind, solar, hydro, nuclear, fossil), fossil-fuel mining, transport (ICE vs EV, network externalities), heating (gas furnaces vs heat pumps, building insulation), energy-intensive and regular tradables, and energy inputs into intermediate and final demand.
  - Policy instruments: carbon pricing across modeled sectors, phase-out of free ETS1 allowances over 2026-2034, ETS2 introduced in 2028 (fully anticipated), CBAM modeled as a charge on energy-intensive tradable imports (scope 1 and selected scope 2/3), and flexible revenue recycling options (subsidies, labor/capital/consumption tax cuts, lump-sum rebates).
- Calibration and linkage to bottom-up evidence:
  - Sector-specific investment needs for abatement are calibrated to be consistent with bottom-up studies (e.g., costs of electrification, heating and insulation, EII abatement).
  - The model captures need for renewables backup and electricity grid considerations; interconnector/grid-specific investment not explicitly modeled but estimated to have small aggregate impact in simulations.

### Policy scenarios and sensitivity of outcomes to revenue recycling
- Three main scenarios (identical emission targets; differ by revenue recycling):
  1. Central scenario: Two-thirds of carbon pricing revenues to “green subsidies” and one-third to labor tax cuts.
     - Two-thirds of subsidies allocated to renewable energy capital; remaining third split equally among EVs, insulation, and electricity-based heating (heat pumps).
  2. Labor-tax-cut scenario: All carbon pricing revenues used to cut labor taxation (no subsidies).
  3. Lump-sum transfer scenario: All revenues rebated to households as lump-sum transfers (no subsidies or tax cuts).
- Key scenario comparisons and quantitative effects:
  - Central scenario:
    - Peak green investment: ~1.6 percentage points of GDP; annual average 1.3 percentage points of GDP during 2026-2035.
    - Peak aggregate investment: ~1.2 percentage points of GDP; net GDP increases by almost 0.2 percent on a net basis; exports fall by 2.5 percent (real exchange rate appreciation).
    - Electricity prices: rise by about 5 percent above baseline by 2035 (about 0.5 percent per year).
    - Inflation and interest rate dynamics: headline and core inflation initially fall (exchange rate appreciation); monetary policy eases slightly early on then becomes slightly restrictive in latter part of the horizon as investment and inflation recover.
  - Labor-tax-cut (no subsidies) scenario:
    - Peak green investment: ~1.2 percentage points of GDP (about 0.3 percentage points lower than central).
    - Peak aggregate investment: ~0.9 percentage points of GDP (about 0.3 percentage points lower than central).
    - Required carbon prices to meet targets are about $50 higher than in the central scenario.
    - Real GDP marginally weaker and inflation a bit higher than central, but households’ consumption rises materially due to larger labor tax cuts.
  - Lump-sum transfer scenario:
    - Performs more poorly than the central scenario on GDP and energy prices (fails to boost renewables capacity and does not stimulate labor supply).
- Mechanisms highlighted:
  - Green subsidies lower the carbon price needed to meet targets and support larger renewables deployment, which helps contain electricity price increases.
  - Labor tax cuts stimulate labor supply and consumption, improving household incomes and supporting GDP.
  - Lump-sum rebates lack allocative incentives and therefore lead to higher carbon prices and weaker investment outcomes.

### Fiscal and public vs private investment implications
- Illustrative public financing assumptions:
  - Assumed public share of aggregate investment needs: illustrative 40 percent (broadly in line with some studies and debates).
  - Under a 40/60 public/private split, peak increase in public investment implied by model scenarios:
    - Up to 0.4 percentage points of GDP on average (0.5 percentage points of GDP at peak) in central scenario variants that rely more on subsidies.
    - In a scenario with full recycling into lump-sum transfers and a peak aggregate investment impact of about 0.9 percent of GDP, a 40 percent public share implies a peak public investment increase of about 0.4 percent of GDP (0.3 percent on average over 2026-2035).
  - These public financing needs would be about half of projected ETS1 and ETS2 revenues (projected carbon pricing revenues could reach about 1 percent of GDP).
- Range in the literature on public share:
  - Published estimates vary from about 17 percent to 60 percent public share depending on methodology and sectoral assumptions (examples: Andersson, Köhler-Ulbrich, and Nerlich, 2025; European Investment Bank, 2021; Pisani-Ferry and Mahfouz, 2023; Baccianti, 2022; IEA, 2022).
  - Pisani-Ferry and Tagliapietra (2024) suggest public contribution may range from 25 to 50 percent.
- Sectors with greatest public financing needs:
  - Rail, public transport, and buildings typically require higher public funding shares (examples: Baccianti, 2022 scenario results: up to 90-95 percent public coverage for rail/public transport gaps in a high-public scenario; 45 percent public share for buildings in a balanced mix).
- Role of EU budgetary instruments:
  - EU programs and funds (MFF 2021-27, Next Generation EU, Recovery and Resilience Facility) already provide significant public funding for the green transition; these include grants, subsidies, tax credits, and guarantee/risk-sharing instruments.

### Robustness, limitations, and interpretation
- Model strengths:
  - Bridges bottom-up sectoral investment detail with top-down general equilibrium dynamics, producing intermediate estimates (e.g., around EUR 400 per abated tCO2e in GMMET versus ~EUR 500 in many bottom-up studies and much lower in many top-down studies).
  - Captures sectoral investment specificity (buildings, transport, renewables, energy-intensive manufacturing) while retaining macro feedbacks.
- Limitations and caveats:
  - Some mitigation measures and sectors are not modeled in detail (e.g., certain ETS1/ETS2 measures like car emission regulations; agriculture and non-CO2 gases not modeled).
  - Some investment needs (e.g., specific interconnectors, grid expansion) are not explicitly modeled; authors argue impacts on aggregate investment are likely small within their scenarios.
  - The model does not capture certain dynamic benefits such as R&D-driven technological progress or long-run cost declines from scale and learning-by-doing beyond what is parameterized.
  - Results depend critically on assumptions about revenue recycling, phasing out free allowances, ETS2 introduction timing (assumed 2028), and slotting of sectoral 2035 ETS targets (assumptions: 2035 ETS1 target = 47 percent reduction below baseline; ETS2 = 40 percent below baseline, given ETS2 reduction pace twice that of ETS1 between 2030 and 2035).

### Conclusion and policy implications
- Aggregate investment cost:
  - Granular GE modeling implies an average aggregate investment cost of around 1 percent of GDP over the coming decade, with a peak of about 1.2 percent of GDP—higher than most “top-down” studies but below many “bottom-up” totals.
  - About one-third of additional green investment is offset by declines in brown investment—lower fossil-fuel extraction, fossil-fuel-based electricity generation and gas heating investment.
- Macroeconomic implications under an illustrative policy mix (carbon pricing + green subsidies + labor tax cuts):
  - Modest implications for GDP, consumption, electricity prices, and inflation.
  - Smart revenue recycling (green subsidies and labor tax cuts) materially improves macroeconomic outcomes relative to lump-sum rebates by containing energy prices, supporting investment, and stimulating labor supply.
- Policy trade-offs:
  - Carbon pricing revenues afford opportunities to address market failures and reduce distortions (e.g., via subsidies for deployment/innovation and cuts to labor taxation), but choices imply trade-offs across growth, energy price containment, energy security, fiscal consolidation, and income distribution objectives.

*Source: IMF Working Paper — The EU’s Energy Transition: Investment Impact and Role of Carbon Pricing Revenue Recycling (chapter and references content).*

### 2028. Our simulations find that this approach is the cornerstone of a smooth energy transition. So is smart

### wpiea2026046-source-pdf - 2028. Our simulations find that this approach is the cornerstone of a smooth energy transition. So is smart

### Revenue recycling and green subsidies: findings
- Recycling a material fraction of the large projected increase in carbon pricing revenues into green subsidies:
  - Supports investment and GDP.
  - Speeds up the expansion of renewables supply, key to keeping electricity prices in check.
  - Helps offset costs of decarbonization investments for households (example: electric heat pumps).
  - Implementation forms: feebates, direct subsidies, or tax credits.
- Recycling a fraction of carbon pricing revenues into labor income tax cuts targeted to lower incomes:
  - Could support consumption.
  - Could alleviate adverse effects of higher carbon pricing on income inequality.
- Complementary measures to minimize costs and maximize benefits:
  - Reduce policy uncertainty to incentivize early investment (reference to IMF 2022).
  - Fund European energy-related public goods (e.g., inter-connectors with large economic gains).
  - Consider carbon price floors or corridors to dampen carbon price fluctuations.
  - Coordinate industrial policy at the EU level to reduce risks of a costly subsidy race.

### Policy recommendations and implementation details
- Clarify and anchor policy trajectories:
  - Recent adoption of the EU’s 2040 emissions target and NDC for 2035 provides clarity on scale and trajectory.
  - Swift clarification of accompanying regulatory standards (example: conclude review into emissions standards for cars and vans).
  - Produce a more detailed plan for implementation of the EU’s Green Deal Industrial Plan.
- Fiscal arrangements:
  - Accommodate spending on EU public goods related to the energy transition in the EU’s multiannual financial framework or through joint spending by some or all member states.
- Structural and financial-sector complements:
  - Simpler and stronger taxonomy of green investment products.
  - Streamline permitting and planning processes for renewables.
  - Invest in skills to smooth worker reallocation away from contracting jobs.
  - Deepen the capital markets union to facilitate access to finance for green investment and capital reallocation.
- Regulatory and market-stability devices:
  - Carbon price floors or corridors to reduce volatility and support investment.

### Current EU climate strategy and targets (Annex I)
- Overarching commitment:
  - Climate neutrality by 2050 (legally binding).
  - Interim targets for 2030, 2035, 2040.
- Specific targets and legal status:
  - 2030: ≥55 percent reduction vs. 1990 — Yes (legally binding; enshrined in EU Climate Law; part of Fit-for-55 package).
  - 2035: 66.25–72.5 percent reduction vs. 1990 — No (not legally binding; supported in Fall 2025 as interim range).
  - 2040: 90 percent reduction vs. 1990 (including up to 5 percent through carbon credits) — Yes (amended EU Climate Law cleared trilogue stage).
  - 2050: Climate neutrality — Yes (legally binding under EU Climate Law; net-zero GHG emissions).
- Flexibility mechanisms:
  - Use of international carbon credits for up to 5% of the 2040 emission reduction target.
  - Emergency brakes and review clauses to accommodate shocks and uncertainty.

### Sector-specific policies and targets (Table AI.2 summary)
- EU ETS 1:
  - Objective: 62 percent emissions reduction by 2030 relative to 2005 levels.
  - Coverage: Power generation, heavy industry, intra-EU aviation, maritime.
  - Note on LRF and cap settings: LRF set at 4.3 percent for the period 2024-2027 and 4.4 percent from 2028 onward; two one-off rebasing reductions agreed (2024 and 2026); maritime transport added to ETS1; aviation has separate emissions cap.
- EU ETS 2:
  - Objective: 42 percent emission reduction by 2030 relative to 2005 levels.
  - Planned implementation starting from 2028.
  - Coverage: Buildings, road transport, small-scale fuel use.
  - Market Stability Reserve aimed to keep allowances near €45–55 per ton of CO₂.
- Renewable Energy Directive (RED III):
  - Target: 42.5 percent share of renewables in final energy consumption by 2030 with an aspirational goal of 45 percent.
  - Coverage: Electricity, heating/cooling, transport.
- Energy Efficiency Directive (EED):
  - Target: 11.7 percent reduction in final energy consumption relative to 2020 EU reference scenario projection for 2030.
  - Coverage: Cross-sectoral (buildings, transport, industry).
- Effort Sharing Regulation (ESR):
  - Target: 40 percent emissions reduction relative to 2005 levels by 2030.
  - Coverage: Transport (non-ETS), buildings, agriculture, waste, small industry.
- LULUCF Regulation:
  - Target: 310 Mt CO₂-eq net removals across the EU by 2030.
  - Coverage: Land use, forestry, carbon sinks.
- CO₂ Standards for Cars and Vans:
  - Target: 100 percent reduction in new car and van CO₂ emissions (zero-emission vehicles only) by 2035 — a target the EC proposed to reduce to 90 percent in December 2025.
  - Coverage: Road transport.
- Energy Performance of Buildings Directive (EPBD):
  - Target: All new buildings zero-emission by 2030; public buildings by 2028.
  - Coverage: Residential and non-residential buildings.
- ReFuelEU:
  - Target: Minimum Sustainable Aviation Fuel (SAF) of 2 percent by 2025 rising to 70 percent by 2050; Minimum Synthetic Fuel Share rising from 1.2 percent in 2030 to 35 percent in 2050.
  - Coverage: Air transport.
- Multi-layered policy design:
  - Examples: Buildings are covered by ETS2, EED, ESR, EPBD; Road transport is covered by ETS2 and CO2 standards including the 2035 ICE car ban.
  - Rationale: Regulations can complement carbon pricing where carbon pricing alone may not send clear enough signals for long-horizon investments.

### Model extension: GMMET and key energy-related features (Annex II)
- Model type and purpose:
  - GMMET: large-scale non-linear structural New-Keynesian dynamic general equilibrium model; builds on GIMF.
  - Used to analyze energy production, trade, use, and emissions implications for macroeconomy and policy.
- Key energy-related features:
  - Fossil fuels (oil, fossil gas and coal) mining requires labor, physical capital and endowment; initial shares match revenue shares; supply elasticities reproduced empirically; fossil fuels internationally traded.
  - Electricity generation from five technologies: Coal, fossil gas, nuclear power, hydroelectric power, and renewables.
  - Renewable intermittency modeled with a flexible backup (gas generation); backup capacity derived from cost-minimization considering variable and fixed costs and distribution of weather regimes.
  - Transportation sector distinguishes ICE cars and electric vehicles; includes stock-flow accounting and explicit charging/fueling station network externalities.
  - Non-combustion GHG emissions tracked with sector-specific abatement technologies (not exploited in present paper).
  - Government instruments include carbon prices and subsidies for low-emission technologies (renewables electricity capital, EVs, energy-efficiency capital, insulation).
- Monetary policy implementation:
  - Standard policy rule responding to deviation of core inflation from target and the neutral rate; rule includes expected future inflation and past inflation for interest rate smoothing.
  - Core inflation excludes energy from consumption basket and offsets fiscal measures that directly affect consumer prices (e.g., EV subsidies), so monetary policy looks through direct price impacts of mitigation policies.

### Energy-efficiency capital: modeling and calibration
- Sector split:
  - Manufacturing split into energy-intensive tradable goods (cement, fertilizers, metals) and other tradable goods.
  - Emissions reduction via energy substitution and investing in energy-efficiency capital.
  - Energy-intensive sector produces an intermediate good for other tradables.
- Nested CES structure:
  - Bottom stage: different types of energy aggregated into an energy bundle.
  - Second stage: energy bundle combined with energy-efficiency capital.
  - Composite used jointly with capital–labor bundle in production (approach per Pehl, Schreyer and Luderer (2023)).
- Calibration specifics:
  - Elasticity of substitution between energy and energy-efficiency capital set to 1.7.
  - Initial share of energy-efficiency capital assumed equal to share of energy intermediate consumption in sectoral domestic supply.
  - Resulting shares: about a quarter of capital stock is energy-efficiency capital for the energy-intensive tradable goods sector and about half that share for the general tradable goods sector.

### Heating sector: structure and calibration
- Heating sector design:
  - Final heating services demanded by households and used in non-tradable goods production.
  - CES bundle combines heat and insulation capital; insulation capital functions analogously to energy-efficiency capital.
  - Heat component bundles electricity-based and gas-based generation, each combined with dedicated capital stock.
  - When relative price of heat rises, substitution toward additional insulation capital occurs.
- Calibration challenges and empirical benchmarks:
  - Historical estimates:
    - European Commission (2019b): annual energy renovation investment in EU28 during 2012–2016 approximately €280–290 billion; cumulative investment roughly €1.4 trillion; direct emissions from residential and commercial buildings declined around 12 percent over same period.
      - Scaling suggests a cost of €117 billion per ppt of emissions reduction (if renovation investment assumed behind emission reduction).
    - IEA (World Energy Investment 2025): approximately $55–70 billion per year invested in buildings energy efficiency in the EU (excluding the UK) between 2015 and 2024, implying cumulative investment in the order of $600 billion; residential and commercial direct emissions declined -21 percent over this period, implying about $29 billion per ppt of emissions reduction (assuming causality and linear scaling).
  - Reconciling differences:
    - EC estimates based on bottom-up renovation cost data (may overstate expenditure cost).
    - IEA figures based on less granular categories (may understate costs).
    - Calibration choice: consider half the figure implied by the EC study, yielding a calibration target of about €60 per ppt reduction in sectoral emissions (roughly between EC and IEA estimates).
    - Calibration supported by adjustment dynamics consistent with CPAT model (Black, Parry, Mylonas and Zhunussova (2023)).

*Italic source: IMF WORKING PAPERS — The EU’s Energy Transition: Investment Impact and Role of Carbon Pricing Revenue Recycling (content from provided PDF).*

### References

### References

### Models and Methodologies
- Aboumahboub, T., C. Auer, N. Bauer, L. Baumstark, C. Bertram, S. Bi, J. Dietrich, A. Dirnaichner, A. Giannousakis, M. Haller, J. Hilaire, D. Klein, J. Koch, A. Körner, E. Kriegler, M. Leimbach, A. Levesque, A. Lorenz, G. Luderer, S. Ludig, M. Lüken, A. Malik, S. Manger, L. Merfort, I. Mouratiadou, M. Pehl, R. Pietzker, F. Piontek, L. Popin, S. Rauner, R. Rodrigues, N. Roming, M. Rottoli, E. Schmidt, F. Schreyer, A. Schultes, B. Sörgel, J. Strefler, and F. Ueckerdt. 2020. “REMIND – Regional Model of Investments and Development – Version 2.1.0.”
- Carton, B., C. Evans, D. Muir, and S. Voigts. 2023. “Getting to Know GMMET: The Global Macroeconomic Model for the Energy Transition.” IMF Working Paper 23/269. International Monetary Fund.
- Kumhof, M., D. Muir, S. Mursula, and D. Laxton. 2010. “The Global Integrated Monetary and Fiscal Model (GIMF) – Theoretical Structure.” IMF Working Paper 10/34. International Monetary Fund.
- Pehl, M., F. Schreyer, and G. Luderer. 2023. "Modelling long-term industry energy demand and CO2 emissions in the system context using REMIND (version 3.1.0)." Geoscientific Model Development Discussions 2023: 1-29.
- Varga, J., W. Roeger., and J. Velt. 2022. “E-QUEST: A Multisector Dynamic General Equilibrium Model with Energy and a Model-Based Assessment to Reach the EU Climate Targets.” Economic Modelling 114: 105911.

### Climate Policy, Social Costing, and Assessment Tools
- Anthoff, D., and R. S. Tol. 2013. “The Uncertainty about the Social Cost of Carbon: A Decomposition Analysis Using FUND.” Climatic Change 117 (3): 515–530.
- Nordhaus, W. 2014. “Estimates of the Social Cost of Carbon: Concepts and Results from the DICE-2013R Model and Alternative Approaches.” Journal of the Association of Environmental and Resource Economists 1 (1/2): 273–312.
- Black, S., I. Parry, V. Mylonas, and K. Zhunussova. 2023. "The IMF-World Bank Climate Policy Assessment Tool (CPAT): A Model to Help Countries Mitigate Climate Change." IMF Working Paper 23/128. International Monetary Fund.
- Network for Greening the Financial System (NGFS). Forthcoming, “The macroeconomic effects and potential monetary policy trade-offs of climate mitigation policies”.
- Shapiro, A. F., & Metcalf, G. E. 2023. “The macroeconomic effects of a carbon tax to meet the US Paris agreement target: The role of firm creation and technology adoption.” Journal of Public Economics, 218, 104800.

### EU Policy, Directives, and Institutional Analyses
- European Commission. 2019a. The European Green Deal. COM (2019) 640 final.
- European Commission. 2019b. “Comprehensive Study of Building Energy Renovation Activities and the Uptake of Nearly Zero-Energy Buildings in the EU – Final Report.” Directorate-General for Energy, Brussels.
- European Commission. 2021. “Commission Staff Working Document: Impact Assessment Report Accompanying the Document Proposal for a Directive of the European Parliament and of the Council Amending Directive (EU) 2018/2001.” SWD(2021) 621 final, Brussels.
- European Parliament and Council. 2021. Regulation (EU) 2021/1119 Establishing the Framework for Achieving Climate Neutrality (European Climate Law).
- Dolphin, G., and G. Ferrucci. 2025. "The EU’s CBAM: Implications for Member States and Trading Partners." IMF Working Paper 2025/125. International Monetary Fund.
- Draghi, Mario. 2024. “The Future of European Competitiveness.” Report to the European Commission. Brussels.
- Pisani-Ferry, J., and S. Mahfouz. 2023. “The Economic Implications of Climate Action.” Report to the French Prime Minister, Inspection Générale des Finances, France Stratégie.
- Pisani-Ferry, J., and S. Tagliapietra. An investment strategy to keep the European Green Deal on track. Bruegel, 2024.

### Climate Finance and Investment Needs
- Andersson, M., P. Köhler-Ulbrich, and C. Nerlich. 2025. “Green Investment Needs in the EU and Their Funding.” ECB Economic Bulletin, Issue 1/2025. European Central Bank.
- Baccianti, C. 2022. “The Public Spending Needs of Reaching the EU’s Climate Targets.” In Greening Europe: 2022 European Public Investment Outlook, edited by F. Cerniglia and F. Saraceno. Cambridge: Open Book Publishers.
- Calipel, C., C. Henry, and A. Cornaggia (I4CE). 2025. The State of Europe’s Climate Investment, 2025 Edition. Climate Report, June 3.
- Climate Policy Initiative. 2025. Global Landscape of Climate Finance 2025: Tracking Methodology.
- European Investment Bank. 2021. EIB Investment Report 2020/2021: Building a Smart and Green Europe in the COVID-19 Era.
- International Energy Agency. 2022. World Energy Investment 2022. Paris: IEA.
- International Energy Agency. 2024. World Energy Investment 2024. Paris: IEA.
- International Renewable Energy Agency (IRENA). 2025. Regional Energy Outlook: European Union. Abu Dhabi.

### Macro and Sectoral Analyses Relevant to Europe
- Chateau, J., A. Miho, and M. Borowiecki (OECD). 2023. “Economic Effects of the EU’s ‘Fit for 55’ Climate Mitigation Policies: A Computable General Equilibrium Analysis.” OECD Economics Department Working Paper No. 1775. Paris: OECD Publishing.
- Coenen, G., M. Lozej, and R. Priftis. 2024. “Macroeconomic Effects of Carbon Transition Policies: An Assessment Based on the ECB’s New Area-Wide Model with a Disaggregated Energy Sector.” European Economic Review 167: 104798.
- Darvas, Z., and G. Wolff. 2022. “A Green Fiscal Pact for the EU: Increasing Climate Investments While Consolidating Budgets.” Climate Policy 23 (4): 409–417.
- Dolphin, G., R. Duval, H. Rojas-Romagosa, and G. Sher. 2024. "The Energy Security Gains from Strengthening Europe’s Climate Action." IMF Departmental Paper 24/005. International Monetary Fund.
- D'Arcangelo, F., D. Bartolini, G. Di Bella, R. Duval, X. Li, H. Rojas-Romagosa and F. Toscani. 2026. "The Macroeconomic Gains from Deeper Energy Market Integration in Europe." IMF European Departmental Paper. International Monetary Fund.
- Garcia, P., P. Jacquinot, Č. Lenarčič, K. Mavromatis, N. Papadopoulou, and E. Silgado-Gómez. 2025. "Green Transition in the Euro area: Domestic and Global Factors." European Economic Review 182: 105206.
- Hodge, A., R. Piazza, F. Hasanov, X. Li, M. Vaziri, A. Weller, and Y. Wong. 2024. "Industrial Policy in Europe: A Single Market Perspective", IMF Working Papers 24/249. International Monetary Fund.
- Eble, S., I. Bunda, O. Adilbish, N. Budina, G-H. Hong, M. Malak, S. Mohona, A. Myrvoda, A. Pitt, and K. Primus. 2025. "Long-Term Spending Pressures in Europe." IMF European Departmental Paper.

### Socioeconomic and Comprehensive Assessments
- Weitzel, M., Vandyck, T., Los Santos, L. R., Tamba, M., Temursho, U., and Wojtowicz, K. 2023. “A Comprehensive Socio-Economic Assessment of EU Climate Policy Pathways.” Ecological Economics 204: 107660.
- Nordhaus, W. 2014. “Estimates of the Social Cost of Carbon: Concepts and Results from the DICE-2013R Model and Alternative Approaches.” Journal of the Association of Environmental and Resource Economists 1 (1/2): 273–312.

*References section of The EU’s Energy Transition: Investment Impact and Role of Carbon Pricing Revenue Recycling, Working Paper No. WP/2026/046*

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_Source: https://www.imf.org/-/media/files/publications/wp/2026/english/wpiea2026046-source-pdf.pdf_