Environmental regulation, firm heterogeneity and macroeconomic volatility

We expand a conventional Real Business Cycle (RBC) model incorporating environmental regulation and heterogeneous firms in order to investigate the interrelationships between firm heterogeneity, environmental policy, and economic uncertainty. The findings are as follows: First, the impact of the environmental regulation on macroeconomic volatility is significantly influenced by the source of business-cycle variation. Second, firm hetero- geneity has relevant implications for macroeconomic volatility, regardless of the origin of the macroeconomic shock. Finally, the dynamics of the distribution of capital stocks and productivity across productive plants cause the aggregate reaction to the stricter environ- mental policy to be nonlinear, implying a different macroeconomic adjustment than the analogous Representative agent counterpart. The key micro-parameters are estimated consistently with data of regulated firms under the EU Emissions Trading System (EU ETS).