Market Mechanisms and Economic Policy for Decarbonisation

• The interplay between market mechanisms, climate policy instruments and institutions
• European emissions trading and the coordination of national and European climate and energy policy
• Macroeconomic decarbonisation, electricity markets and electrification
• Designing climate policy measures for sectors with emissions that are difficult to avoid (‘hard-to-abate’ sectors)
   

The research focus ‘Market Mechanisms and Economic Policy for Decarbonisation’ examines the cross-sectoral and macroeconomic aspects of climate and energy policy, as well as the economic transformation processes resulting from the intended pathway to climate neutrality in Germany and the EU. The focus is on the ex-ante analysis of the impacts and design of future economic policy measures and markets aimed at decarbonisation. To this end, analytical and numerical general equilibrium models are combined with energy system and partial market analyses. The research centres on three key areas. 

Firstly: the functioning and design of markets for pricing CO2 emissions. The research examines how the German and European emissions trading schemes should be designed from an economic perspective, and how these can be coordinated with national climate and energy policy measures in the transport, buildings and heating sectors, and further developed within the context of the new European emissions trading scheme, ETS2. The analysis also takes into account investment decisions by households with limited rationality regarding durable, energy-intensive consumer goods. The aim is to understand the interactions between CO₂ pricing, regulation and subsidies, and to derive policy options for an effective and cost-efficient climate policy.

Secondly: the spatial and macroeconomic adjustments to decarbonisation. Despite shared European climate targets, regions differ in terms of their economic structure, their potential for utilising renewable energy and their CO₂ abatement costs. Consequently, today’s industrial locations do not necessarily offer advantages for climate-neutral production. To analyse these changes, a quantitative spatial equilibrium model of the EU at NUTS 2 level is to be developed, which maps the spatial concentration and relocation of economic activities whilst taking into account key agglomeration and dispersion mechanisms. In addition, macroeconomic models will be linked to microsimulations, and household, production and energy market data will be integrated. This will enable an examination of the efficiency and distributional effects of market-based and regulatory instruments, as well as the allocation of revenues across households, sectors, regions and countries. Labour market adjustments will also be taken into account.

Thirdly: the decarbonisation of sectors in which emissions are particularly difficult to avoid (‘hard-to-abate’ sectors). These include, for example, the steel industry and aviation. Electrification and alternative fuels and power sources open up opportunities for reducing emissions. High market entry costs, economies of scale and imperfect competition, as well as financing frictions, influence the effectiveness of climate policy instruments. The study examines how CO₂ pricing, technology funding and measures to prevent the relocation of emissions abroad – such as the carbon border adjustment mechanism – operate under these conditions. Particular attention is paid to incentives for innovation and the introduction of climate-friendly technologies. To analyse these developments, the research will focus primarily on the development and application of multi-sectoral macroeconomic equilibrium models, as well as highly detailed models in specific sectors, which integrate economic decision-making behaviour, market interactions, technological aspects and regulatory frameworks.