We propose a new model of a small open economy with efficient energy use to investigate the inflationary dynamics along
the green transition. The model incorporates the production of
green energy that substitutes exogenous brown energy sources
in energy production. Production is characterized by low substitutability between resource and traditional inputs that firms
can alter through directed input-saving technical change.
We propose a new model of a small open economy with efficient energy use to investigate the inflationary dynamics along
the green transition. The model incorporates the production of
green energy that substitutes exogenous brown energy sources
in energy production. Production is characterized by low substitutability between resource and traditional inputs that firms
can alter through directed input-saving technical change. We
study transitional dynamics induced by exogenous increases
of brown energy prices and/or changes in the brown energy
taxation; green subsidies and green public investment. Increases
in brown energy prices and taxes decrease the usage of brown
energy but do not expand significantly the green sector, they simply improve energy efficiency use, surging firm’s marginal costs
leading to greenflation and output losses. Public investment and
subsidies effectively increase the usage of green energy. Green
investment expands output and reduces green energy prices
as it increases the productivity of the green sector. Subsidies
imply a slower transition with small output costs and elevated
green energy prices.
