Evaluating the Carbon-Macroeconomy Relationship

This paper studies the nonlinear adjustment between industrial production and carbon prices - coined as 'the carbon-macroeconomy relationship' - in the EU 27. Our findings show that (i) macroeconomic activity is likely to affect carbon prices with a lag, due to the specific institutional constraints of this environmental market; (ii) the joint dynamics of industrial production and carbon prices seem adequately captured by two-regime threshold error-correction and two-regime Markovswitching VAR models compared to linear models as main competitors. Besides, an alternative modelling strategy is proposed based on smooth transition and univariate Markov-switching autoregressive models.