This paper uses the Dynamic Stochastic General Equilibrium (DSGE) model featuring a
variable that captures energy produced from fossil fuels, in an economy with carbon tax
applied under two tax rules scenarios: Laissez-Faire and Pigouvian tax rules. An
externality, representing the energy produced from fossil fuel, is introduced in the baseline
Real Business Cycle (RBC) model. Because of the added externality, an inefficient
allocation takes place, and a Pigouvian tax rule is implemented as policy tool to manage
overall fossil fuel energy consumption and effects. The study also explores the influences
on macroeconomic aggregates under the two tax regimes proposed. Furthermore, the
study provides an analysis of outcomes for both scenarios under two different shocks:
Total Factor Productivity (TFP) and Price of energy produced from fossil fuel – Prices of
WTI Crude Oil (West Texas Intermediate – US base Crude Oil) were used as a proxy to
simulate price shocks on fossil fuels. Finally, the study shades a light on climate policies
influence on outcomes over the business cycle and types of shock that matters for policy
preference, it concludes with insights about the Pigouvian Tax implementation.
