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Contact: Carl Pasurka, 202-566-2275

Presenter:  Nicholas Muller (Tepper School of Business, Carnegie Mellon University)

Description:  The present paper computes the monetary damages from air pollution and primary greenhouse gases and deducts these damages from Gross Domestic Product in the United States economy from 1957 to 2016. Employing this adjusted measure of output, the analysis considers the relationships among environmental policy, volatility in year-over-year consumption, and macroeconomic policy. The conceptual modeling yields two key insights. First, volatility in consumption depends on the covariance of market goods and services and pollution damage. The sign of the covariance hinges on the stringency of pollution control. Without pollution legislation, damages and market output co-vary positively which dampens variation in the adjusted measure of consumption. Conversely, stringent environmental policy induces negative covariance between damages and market output. This amplifies variation in consumption. Second, using the adjusted measure of output, the natural interest rate depends on the intertemporal changes in pollution intensity. Economies on a cleaning-up path justify a higher natural rate. Societies growing more pollution intensive suggest a lower natural rate. In an empirical application to the U.S. economy, it is shown that the natural rate inclusive of pollution damages differs significantly from estimates of the natural rate in the literature. Second, the implication of major federal air pollution legislation enacted in the 1970s induced a reversal of the covariance between damages and output. The effect of this on year-over-year variance in per capita consumption, net of pollution damage, is appreciable.