Growth and Mitigation Policies with Uncertain Climate Damage

Climate physics predicts that the intensity of natural disasters will increase in the future due to climate change. We present a stochastic model of a growing economy where natural disasters are multiple and random, with damages driven by the economy’s polluting activity. We provide a closed-form solution and show that the optimal path is characterized by a constant growth rate of consumption and the capital stock until a shock arrives, triggering a downward jump in both variables. Optimum mitigation policy consists of spending a constant fraction of output on emissions abatement. This fraction is an increasing function of the arrival rate, polluting intensity of output, and the damage intensity of emissions. We subsequently extend the baseline model by adding climate-induced fluctuations around the growth trend and stock-pollution effects, demonstrating robustness of our results. In a quantitative assessment of our model we show that the optimal abatement expenditure at the global level may represent 0.9% of output, which is equivalent to a tax of $70 per ton carbon.