Energy mix, technological change, and the environment

Abstract

This paper studies the relationship between the energy mix and the environment using a theoretical framework in which two alternative energy sources are considered: fossil fuels (dirty energy) and renewable energy (clean energy). We find that a positive aggregate productivity shock increases energy consumption and emissions but reduces energy intensity and emissions per unit of output as renewable energy consumption increases, that is, carbon emissions are procyclical but emissions per unit of output are countercyclical. Second, an energy efficiency improvement provokes a “rebound effect” above 100% (the backfire effect), resulting in a rise of pollutant emissions by increasing energy use. Third, a technological improvement in emissions leads to a reduction in emissions per unit of fossil fuel, but also implies a slow-down in the adoption of renewable energy sources. Finally, we consider the case of a decentralized economy in which the government chooses an optimal specific tax on fossil fuel to maximize social welfare. We show that the “second-best” policy is highly effective in correcting the negative effects of the environmental externality and able to almost achive the centralized economy outcome.