"What do firms expect future carbon prices to be, and how do they formulate their expectations? One basis for decision-making is likely to be the climate pledges of policymakers. However, policy announcements trigger the desired behavioural changes only if individuals believe these will be followed by actual policy actions.

The authors of this paper model and analyse the dynamic interaction between heterogeneous (diverse) expectations, investment decisions and climate mitigation policymaking, examining how firms invest in low versus high carbon capital depending on their beliefs about future carbon prices. They show that weak policy commitment, especially when combined with ambitious emission mitigation announcements, can trap the economy into a vicious circle of credibility loss, carbon-intensive investments and increasing risk perceptions, ultimately leading to a failure of the low-carbon transition. They identify the conditions that would lead to a successful transition and provide a numerical application for the EU economy. The results offer valuable insights for designing and communicating effective climate policies."

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