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Climate Policy and Catastrophic Change: Be Prepared and Avert Risk

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  • Frederick van der Ploeg
  • Aart de Zeeuw

Abstract

The 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 Info

Paper provided by Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 118.

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Date of creation: 2013
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Handle: RePEc:oxf:oxcrwp:118

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Keywords: non-marginal climate damages; tipping points; risk avoidance; economic growth; social cost of carbon; capital subsidy; adaptation capital; carbon tax; renewables;

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Cited by:
  1. Rick Van der Ploeg, 2013. "Abrupt Positive Feedback and the Social Cost of Carbon," Economics Series Working Papers OxCarre Research Paper 12, University of Oxford, Department of Economics.

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