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Optimal Climate Policy for a Pessimistic Social Planner

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Listed:
  • Edilio Valentini

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

  • Paolo Vitale

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

Abstract

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.

Suggested Citation

  • Edilio Valentini & Paolo Vitale, 2014. "Optimal Climate Policy for a Pessimistic Social Planner," Working Papers 2014.33, Fondazione Eni Enrico Mattei.
  • Handle: RePEc:fem:femwpa:2014.33
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    References listed on IDEAS

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    1. Antony Millner, 2013. "On Welfare Frameworks and Catastrophic Climate Risks," CESifo Working Paper Series 4442, CESifo Group Munich.
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    5. In Hwang & Frédéric Reynès & Richard Tol, 2013. "Climate Policy Under Fat-Tailed Risk: An Application of Dice," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 56(3), pages 415-436, November.
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    12. Yulei Luo & Eric R. Young, 2010. "Risk-Sensitive Consumption and Savings under Rational Inattention," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 281-325, October.
    13. 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.
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    Keywords

    Climate Change; Climate Policy Targets; Risk Aversion; Pessimism;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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