Australian emissions reduction subsidy policy under persistent productivity shocks

The implementation of emissions reduction policies in Australia has experienced significant volatility over the last decade and remains in doubt due to different attitudes towards such policies by policy makers. One of the critical concerns of policy makers is that the costs of these policies would adversely affect economic activity and result in larger economic volatility. This paper investigates how business cycle fluctuations of the Australian economy, arising from productivity shocks, would be affected under an abatement reduction subsidy policy in which the regulator supports abatement efforts in each period. To answer this question, a real business cycle (RBC) model is applied. The responses of economic and environmental variables to unexpected productivity shocks are presented and compared. The results indicate that the regulator should adjust the abatement subsidy to be pro-cycle, i.e. increase during expansion and decrease during recessions.