Environmental policy and carbon emissions in business cycles with public infrastructure investment

Governments have the incentive to increase public infrastructure investment for the post pandemic world so as to recover the economy, but in doing so more carbon emissions may be generated. This paper explores how gov-ernments should coordinate environmental policy with public infrastructure provision in business cycles to achieve a certain goal of emissions reduction. First, we find that stringent environmental policy is required to realize the emissions reduction goal when there is heavy investment in public infrastructure. Second, we display that in the presence of public infrastructure, the emissions tax is less able to mitigate pollutants than the emissions cap in a productivity shock, and the interaction between environmental policy and public infra-structure can amplify emissions and macroeconomic volatility in a monetary shock. Third, different from the existing literature arguing that optimal environmental policy should be procyclical in business cycles, we show that it could be countercyclical when the government's willingness to provide public infrastructure is small. This paper contributes by incorporating public infrastructure into the environmental dynamic stochastic general equilibrium model.