European green transition: spillovers to the small open economy and welfare implications

Background This paper investigates the macroeconomic and cross-border spillover effects of the European green transition on the Euro area (EA) and a representative small open economy (SOE). Methods A two-region New Keynesian model (EA–SOE model) is developed to quantify the roles of energy price and exchange rate channels in transmitting the transition shock. Results The results show that the cross-border energy price channel dominates the exchange rate channel in shaping SOE macroeconomic responses, while monetary policy in both economies acts as a key mediator. The pace and intensity of the transition critically affect these responses, with more ambitious transitions generating stronger and more persistent effects. Conclusions The transition produces measurable welfare losses, with the EA consistently bearing a larger share of the burden (approximately 3.5 times that of the SOE), while the SOE is particularly vulnerable to inflationary pressures.