Work Package 2: Model development

Description

In the project SoMBI, two models (ADAGIO and DYNK) will be merged to perform a comprehensive analysis of the effects of an EU-wide CO₂ tax and revenue recycling mechanisms both at EU and at Member State level.

ADAGIO is a multi-regional model covering 43 countries (the EU28 among them) which are linked by detailed trade matrices. Fully endogenous prices (including a detailed treatment of margins, tariffs and taxes) and a consistent price transmission mechanism from the factory door all the way to different consumers in the different countries (a way which can include all kinds of emission taxes) ensure that ADAGIO is well placed to deal with the simulations in this project.

The DYNK (Dynamic New Keynesian) model comprises specific modules of energy demand for industry sectors (shares of energy carriers) and private households (energy demand for mobility, heating & appliances). The production module has been elaborated concerning inter-fuel substitution and the link to physical energy flows. Macroeconomic energy and environmental analyses, often with consideration of household characteristics, are the core focus of DYNK. Both models are macroeconomic Input-Output models and integrate a detailed income distribution and consumption module for private households, modelled on the DYNK philosophy. The theory-derived demand modules are based on the 'bufferstock' model of consumption, developments in energy economics ('rebound effect') and demand system theory. A labour market module and the government sector have been added as well. As a mixture between a classic input-output model and a computational general equilibrium model they account for institutional rigidities, e.g. liquidity constraints by consumers, wage bargaining, imperfect competition. Their most important behavioural functions include

1. changes in sector inputs (capital, labour, energy commodities, imported and domestic non-energy commodities) for 62 sectors via trans-log production functions,
2. employment effects via wage curves, and
3. household demand reactions for different income groups via nested demand functions for durable, non-durable and energy commodities.

Other non-energy related modules consider household income, government budgets and investments.

In the project SoMBI, the production module of the multi-regional ADAGIO-DYNK model will be elaborated concerning inter-fuel substitution and the link to physical energy flows which allows a comprehensive analysis of the effects of CO₂ taxation on emissions as well as on the economy. The combined and extended model ADAGIO-DYNK will be used for the simulations in Work Package 3.