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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 optimal reaction to a pending climate catastrophe is to accumulate capital to be better prepared for the disaster and levy a carbon tax to reduce the risk of the hazard by curbing global warming. The optimal carbon tax consists of the present value of marginal damages, the non-marginal expected change in welfare caused by a marginal higher risk of catastrophe, and the expected loss in after-catastrophe welfare. The last two terms offset precautionary capital accumulation. A linear hazard function calibrated to an expected time of 15 years for a 32% drop in global GDP if temperature stays at 6 degrees Celsius implies with a discount rate of 1.4% a precautionary return of 1.6% and a carbon tax of 136 US $/tC. More intertemporal substitution lowers precautionary capital accumulation and lessens the need for a high carbon tax, but implies less intergenerational inequality aversion which pushes up the carbon tax.

Suggested Citation

  • 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.
  • Handle: RePEc:eus:ce3swp:0213
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    References listed on IDEAS

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    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Polasky, Stephen & de Zeeuw, Aart & Wagener, Florian, 2011. "Optimal management with potential regime shifts," Journal of Environmental Economics and Management, Elsevier, vol. 62(2), pages 229-240, September.
    3. Karp, Larry & Tsur, Yacov, 2011. "Time perspective and climate change policy," Journal of Environmental Economics and Management, Elsevier, vol. 62(1), pages 1-14, July.
    4. Richard Tol, 2002. "Estimates of the Damage Costs of Climate Change, Part II. Dynamic Estimates," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 21(2), pages 135-160, February.
    5. Christian Gollier, 2012. "Pricing the Planet's Future: The Economics of Discounting in an Uncertain World," Economics Books, Princeton University Press, edition 1, number 9894.
    6. Derek Lemoine & Christian Traeger, 2014. "Watch Your Step: Optimal Policy in a Tipping Climate," American Economic Journal: Economic Policy, American Economic Association, vol. 6(1), pages 137-166, February.
    7. Tsur, Yacov & Zemel, Amos, 1996. "Accounting for global warming risks: Resource management under event uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1289-1305.
    8. Robert S. Pindyck, 2013. "The Climate Policy Dilemma," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 7(2), pages 219-237, July.
    9. Naevdal, Eric, 2006. "Dynamic optimisation in the presence of threshold effects when the location of the threshold is uncertain - with an application to a possible disintegration of the Western Antarctic Ice Sheet," Journal of Economic Dynamics and Control, Elsevier, vol. 30(7), pages 1131-1158, July.
    10. Martin L. Weitzman, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 703-724, September.
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    Citations

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    Cited by:

    1. Rezai, Armon & van der Ploeg, Frederick, 2014. "Abandoning Fossil Fuel: How Fast And How Much?," CEPR Discussion Papers 9921, C.E.P.R. Discussion Papers.
    2. Armon Rezai & Frederick Ploeg, 2017. "Second-Best Renewable Subsidies to De-carbonize the Economy: Commitment and the Green Paradox," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 66(3), pages 409-434, March.
    3. van der Ploeg, Frederick, 2014. "Abrupt positive feedback and the social cost of carbon," European Economic Review, Elsevier, vol. 67(C), pages 28-41.
    4. Zemel, Amos, 2015. "Adaptation, mitigation and risk: An analytic approach," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 133-147.
    5. Berry, Kevin & Finnoff, David & Horan, Richard D. & Shogren, Jason F., 2015. "Managing the endogenous risk of disease outbreaks with non-constant background risk," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 166-179.

    More about this item

    Keywords

    non-marginal climate policy; tipping points; risk avoidance; economic growth; social cost of carbon; precaution; adaptation capital;

    JEL classification:

    • 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, Innovation, 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; Prices
    • Q38 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Government Policy (includes OPEC Policy)

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