Climate Policy and Catastrophic Change: Be Prepared and Avert Risk
AbstractThe essence of climate policy is how to prepare for catastrophic change and how to reduce the risk of such events occurring. We show within the context of the Ramsey growth model that the optimal reaction to a pending climate catastrophe is, on the one hand, to accumulate capital to be better prepared for when the disaster hits the global economy, and, on the other hand, a carbon tax to reduce the risk of the hazard occurring by curbing demand for fossil fuel and carbon emissions and reversing the increase in global warming in the business-as-usual scenario. The optimal carbon tax consists of the conventional Pigouvian present value of marginal damages, the non-marginal expected change in welfare caused by a marginal higher risk of catastrophe resulting from burning an additional unit of fossil fuel, and the expected loss in after-catastrophe welfare. The last two terms offset the precautionary increase in capital. The results are illustrated with an integrated assessment model of the global economy. A linear hazard function calibrated to a 6.8% chance of a 30% drop in global GDP at 2324 GtC implies an eventual precautionary return (if necessary realized by a capital subsidy) of 1.6% and a global carbon tax of 136 US $/tC. A higher elasticity of intertemporal substitution lowers precautionary capital accumulation and thus lessens the need for a high carbon tax, but also implies less intergenerational inequality aversion which pushes up the carbon tax.
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Bibliographic InfoPaper provided by Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 118.
Date of creation: 2013
Date of revision:
non-marginal climate damages; tipping points; risk avoidance; economic growth; social cost of carbon; capital subsidy; adaptation capital; carbon tax; renewables;
Other versions of this item:
- Frederick van der Ploeg & Aart de Zeeuw, 2013. "CLIMATE POLICY AND CATASTROPHIC CHANGE: Be Prepared and Avert Risk," CEEES Paper Series CE3S-02/13, European University at St. Petersburg, Department of Economics.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
- O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
- Q31 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Demand and Supply
- Q38 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Government Policy (includes OPEC Policy)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-10 (All new papers)
- NEP-ENE-2013-08-10 (Energy Economics)
- NEP-ENV-2013-08-10 (Environmental Economics)
- NEP-RES-2013-08-10 (Resource Economics)
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