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Optimal Climate Policy for a Pessimistic Social Planner

  • Edilio Valentini

    (Department of Economics, University G. d'Annunzio of Chieti-Pescara)

  • Paolo Vitale

    (Department of Economics, University G. d'Annunzio of Chieti-Pescara)

In this paper we characterize the preferences of a pessimistic social planner concerned with the potential costs of extreme, low-probability climate events. This pessimistic attitude is represented by a recursive optimization criterion à la Hansen and Sargent (1995) that introduces supplementary curvature in the social preferences of standard linear-quadratic optimization analysis and, under certain conditions, it can be shown to correspond to the Epstein-Zin recursive utility. The introduction of extra convexity and the separation between risk-aversion and time-preference implies that, independently of the choice of the discount rate, a sharp, early and steady mitigation effort arises as the optimal climate policy, supporting the main recommendation of the Stern Review (Stern, 2007). Nonetheless, we accommodate for its main criticism of using a too low and questionable discount rate (Nordhaus, 2007), while preserving the assumption of a normal (thin-tailed) probability distribution (Weitzman, 2009). Finally, we argue that our theoretical framework is sufficiently general and robust to possible mis-specifications of the model.

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Paper provided by Fondazione Eni Enrico Mattei in its series Working Papers with number 2014.33.

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Date of creation: Mar 2014
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Handle: RePEc:fem:femwpa:2014.33
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  1. de Zeeuw, Aart & Zemel, Amos, 2012. "Regime shifts and uncertainty in pollution control," Journal of Economic Dynamics and Control, Elsevier, vol. 36(7), pages 939-950.
  2. Buchholz, Wolfgang & Schymura, Michael, 2010. "Expected Utility theory and the tyranny of catastrophic risks," ZEW Discussion Papers 10-059, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  3. In Hwang & Frédéric Reynès & Richard Tol, 2013. "Climate Policy Under Fat-Tailed Risk: An Application of Dice," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 56(3), pages 415-436, November.
  4. Robert S. Pindyck & Neng Wang, 2009. "The Economic and Policy Consequences of Catastrophes," NBER Working Papers 15373, National Bureau of Economic Research, Inc.
  5. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  6. Millner, Antony, 2013. "On welfare frameworks and catastrophic climate risks," Journal of Environmental Economics and Management, Elsevier, vol. 65(2), pages 310-325.
  7. Thomas Tallarini, . "Risk-Sensitive Real Business Cycles," GSIA Working Papers 1997-35, Carnegie Mellon University, Tepper School of Business.
  8. Athanassoglou, Stergios & Xepapadeas, Anastasios, 2012. "Pollution control with uncertain stock dynamics: When, and how, to be precautious," Journal of Environmental Economics and Management, Elsevier, vol. 63(3), pages 304-320.
  9. Svenja Hector, 2013. "Accounting for Different Uncertainties: Implications for Climate Investments?," Working Papers 2013.107, Fondazione Eni Enrico Mattei.
  10. Etienne Espagne & Baptiste Perrissin Fabert & Antonin Pottier & Franck Nadaud & Patrice Dumas, 2012. "Disentangling the Stern/Nordhaus Controversy: Beyond the Discounting Clash," Working Papers 2012.61, Fondazione Eni Enrico Mattei.
  11. Antony Millner, 2013. "On Welfare Frameworks and Catastrophic Climate Risks," CESifo Working Paper Series 4442, CESifo Group Munich.
  12. 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 137-66, February.
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