Environmental macroeconomics: from the IS?LM?EE model to a social welfare approach

Abstract

In answer to Daly's original call for an environmental macroeconomics, Heyes incorporated an environmental constraint in the form of an EE or "ecological equilibrium" curve into a simple "Investment/Savings (IS)-Liquidity/Money (LM)" model (Heyes, 2000). Some criticisms and extensions to the Heyes proposal were presented by Lawn to reflect open economy issues and the implications of technological progress (Lawn, 2003, 2007). Recently, Sim (2006) conducted a discussion on the adjustment processes of the IS?LM?EE system. In this paper, a simple framework extending the IS?LM?EE model is presented to address the perceived problem of having to balance the twin macro goals of economic growth and environmental sustainability. This paper shows that unless environmental policy is optimal, the policy maker's decision will lead to unsustainable growth. If, on the contrary, environmental policy is optimal, there is: (a) initially, a finite period of sustainable growth and (b) due to thermodynamic constraints, a gradual adjustment to a stationary sustainable output level. Social preferences, however, play a crucial role in terms of characterising the long-run adjustment process. The aim of this paper is to contribute further to Heyes' original proposal ? the greening of text book macro theory ? and is motivated by Daly's suggestion that macroeconomic theory should promote the basic goals of human development and sustainability.