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Second-best instruments for near-term climate policy: Intensity targets vs. the safety valve

  • Webster, Mort
  • Sue Wing, Ian
  • Jakobovits, Lisa
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    Current proposals for greenhouse gas emissions regulations in the United States mainly take the form of emissions caps with tradable permits. Since Weitzman's (1974) [3] study of prices vs. quantities, economic theory predicts that a price instrument is superior under uncertainty in the case of stock pollutants. Given the general belief in the political infeasibility of a carbon tax in the US, there has been recent interest in two other policy instrument designs: hybrid policies and intensity targets. We extend the Weitzman model to derive an analytical expression for the expected net benefits of a hybrid instrument under uncertainty. We compare this expression to one developed by Newell and Pizer (2006) [6] for an intensity target, and show the theoretical minimum correlation between GDP and emissions required for an intensity target to be preferred over a hybrid. In general, we show that unrealistically high correlations are required for the intensity target to be preferred to a hybrid, making a hybrid a more practical instrument in practice. We test the predictions by performing Monte Carlo simulation on a computable general equilibrium model of the US economy. The results are similar, and we show with the numerical model that when marginal abatement costs are non-linear, an even higher correlation is required for an intensity target to be preferred over a safety valve.

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    Article provided by Elsevier in its journal Journal of Environmental Economics and Management.

    Volume (Year): 59 (2010)
    Issue (Month): 3 (May)
    Pages: 250-259

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    Handle: RePEc:eee:jeeman:v:59:y:2010:i:3:p:250-259
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    1. Quirion, Philippe, 2005. "Does uncertainty justify intensity emission caps?," Resource and Energy Economics, Elsevier, vol. 27(4), pages 343-353, November.
    2. Weitzman, Martin L, 1978. "Optimal Rewards for Economic Regulation," American Economic Review, American Economic Association, vol. 68(4), pages 683-91, September.
    3. Scott, Michael J. & Sands, Ronald D. & Edmonds, Jae & Liebetrau, Albert M. & Engel, David W., 1999. "Uncertainty in integrated assessment models: modeling with MiniCAM 1.0," Energy Policy, Elsevier, vol. 27(14), pages 855-879, December.
    4. S. Paltsev & J. Reilly & H. Jacoby & A. Gurgel & G. Metcalf & A. Sokolov & J. Holak, 2007. "Assessment of U.S. Cap-and-Trade Proposals," Working Papers 0705, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
    5. Jacoby, Henry D. & Ellerman, A. Denny, 2004. "The safety valve and climate policy," Energy Policy, Elsevier, vol. 32(4), pages 481-491, March.
    6. Fell, Harrison & MacKenzie, Ian A. & Pizer, William A., 2008. "Prices versus Quantities versus Bankable Quantities," Discussion Papers dp-08-32, Resources For the Future.
    7. Newell, Richard G. & Pizer, William A., 2008. "Indexed regulation," Journal of Environmental Economics and Management, Elsevier, vol. 56(3), pages 221-233, November.
    8. Roberton Williams, 2002. "Prices vs. Quantities vs. Tradable Quantities," NBER Working Papers 9283, National Bureau of Economic Research, Inc.
    9. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, vol. 46(7), pages 893-911, July.
    10. Roberts, Marc J. & Spence, Michael, 1976. "Effluent charges and licenses under uncertainty," Journal of Public Economics, Elsevier, vol. 5(3-4), pages 193-208.
    11. Cameron Hepburn, 2006. "Regulation by Prices, Quantities, or Both: A Review of Instrument Choice," Oxford Review of Economic Policy, Oxford University Press, vol. 22(2), pages 226-247, Summer.
    12. Warwick J. McKibbin & Peter J. Wilcoxen, 2002. "The Role of Economics in Climate Change Policy," Journal of Economic Perspectives, American Economic Association, vol. 16(2), pages 107-129, Spring.
    13. Martin L. Weitzman, 1974. "Prices vs. Quantities," Review of Economic Studies, Oxford University Press, vol. 41(4), pages 477-491.
    14. Stock, James H & Watson, Mark W, 1988. "Variable Trends in Economic Time Series," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 147-74, Summer.
    15. Pizer, William A., 2002. "Combining price and quantity controls to mitigate global climate change," Journal of Public Economics, Elsevier, vol. 85(3), pages 409-434, September.
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