The paper starts from the observation that innovation and technical progress are only portrayed superficially in the predominant environmental economic top-down models, and that the assumption of perfect factor substitution does not correctly mirror actual production conditions in many energy-intensive production sectors. Bottom-up models, on the other hand, neglect macroeconomic interdependencies between the modelled sector and the general economy. This paper presents a new modelling approach: in an integrated bottom-up/top-down approach based on the example of crude steel production in Germany, it is demonstrated how technological progress can be portrayed as process-related and policy-induced and how the technology choice between limitational processes can be explicitly modelled and implemented in the econometric input-output model PANTA RHEI. The new modelling approach presented permits a process-specific analysis of the impacts of changed frame conditions, the effects of which on the choice of technology, on the one hand, and the technological progress on the other, can be described endogenous to the model. These features are demonstrated in a CO 2 tax simulation. Results show that policy-induced technological change is-besides a switch in production processes-the major source of CO 2 reduction for the steel sector.