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Cost Containment in Climate Change Policy: Alternative Approaches to Mitigating Price Volatility

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Gilbert E. Metcalf

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Abstract

Cap and trade systems are emerging as the front-running policy choice to address climate change concerns in many countries. One of the apparent attractions of this approach is the ability to achieve hard limits on emissions over a control period. The cost of achieving this certainty on emission limits is price volatility. I discuss and evaluate various approaches within cap and trade systems to reduce price volatility. A fundamental trade-off exists between certainty of emission limits and price volatility. A pure carbon tax sacrifices certainty of emission limits in favor of price stability. I discuss how a hybrid carbon tax can be designed to achieve a balance between price stability and emissions certainty. This hybrid, dubbed the Responsive Emissions Autonomous Carbon Tax (REACT), combines the short-run price stability of a carbon tax with the long-run certainty of emission reductions over a control period.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15125.

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Date of creation: Jul 2009
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Handle: RePEc:nbr:nberwo:15125

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H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy
Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters

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