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Business cycles and emission trading with banking

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  • Lintunen, Jussi
  • Kuusela, Olli-Pekka

Abstract

We propose an emission cap adjustment policy for an emission trading system (ETS) that allows banking of allowances for later use and faces business cycle uncertainty. The forward looking banking decisions cause a commitment problem with respect to regulator’s next period allowance supply decision. We tackle the commitment problem by focusing on the Markov equilibrium of the policy. The equilibrium policy has a surprisingly simple structure, combining features from both price and quantity instruments. The regulator’s ability to choose a new cap for each period does not render banking obsolete, but on the contrary, makes banking an integral part of the equilibrium policy. Using data from the EU ETS to calibrate the model, we solve the Markov equilibrium policy for the case of carbon emissions regulation and compare Markov policies with and without the possibility to bank allowances. A counterfactual analysis of the EU ETS, during the period of 2009–2013, shows that the optimal Markov policy would have led to a steadier allowance price level and a stricter emission regulation than what was actually observed in the EU ETS.

Suggested Citation

  • Lintunen, Jussi & Kuusela, Olli-Pekka, 2018. "Business cycles and emission trading with banking," European Economic Review, Elsevier, vol. 101(C), pages 397-417.
  • Handle: RePEc:eee:eecrev:v:101:y:2018:i:c:p:397-417
    DOI: 10.1016/j.euroecorev.2017.10.015
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    Cited by:

    1. Olli-Pekka Kuusela & Jussi Lintunen, 2020. "A Cap-and-Trade Commitment Policy with Allowance Banking," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 75(3), pages 421-455, March.
    2. Simon Quemin & Raphael Trotignon, 2019. "Emissions trading with rolling horizons," Working Papers 1901, Chaire Economie du climat.
    3. Kollenberg, Sascha & Taschini, Luca, 2019. "Dynamic supply adjustment and banking under uncertainty in an emission trading scheme: The market stability reserve," European Economic Review, Elsevier, vol. 118(C), pages 213-226.
    4. Simon Quemin & Raphael Trotignon, 2018. "Competitive Permit Storage and Market Design: An Application to the EU-ETS," Working Papers 2018.19, FAERE - French Association of Environmental and Resource Economists.
    5. Reyer Gerlagh & Roweno J.R.K. Heijmans, 2018. "Regulating Stock Externalities," CESifo Working Paper Series 7383, CESifo.
    6. Reyer Gerlagh & Roweno J.R.K. Wan, 2018. "Optimal Stabilization in an Emission Permits Market," CESifo Working Paper Series 6950, CESifo.

    More about this item

    Keywords

    Emission trading system; Markov equilibrium; Rational expectations equilibrium; Price-quantity hybrid policy; EU ETS;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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