This study enhances the environmental New Keynesian framework by integrating spatial spillover effects through a dynamic stochastic general equilibrium model. The simulation results reveal that while environmental regulations can lead to welfare losses, a carbon tax levy mitigates these losses more effectively than alternative approaches in New Zealand. What is surprising is the pro-cyclical nature of environmental policies. For spillovers, shocks to capital and labor tax rates substantially curtail emissions in adjacent regions. Further simulation substantiates that higher price dispersion necessitates a reduced growth rate of emissions. These conclusions compel New Zealand to explore diverse policy options for effectively decarbonizing the economy.