The Macro Effects of Anticipating Climate Policy

While the U.S. does not currently have a federal carbon tax, households could expect the government will introduce a carbon tax policy in the future. To understand how the macroeconomy responds to the expectation of a potential future carbon tax, we develop a quantitative life cycle model that allows us to focus on investment in long-lived, sector-specific assets such as coal power plants or wind farms. We find that expectations of future climate policy reduce the return dirty (carbon-emitting) energy capital, shifting the economy towards cleaner energy production. As a result, the anticipation of future climate policy reduces carbon emissions even though there is not actual policy in place. In particular, we find that a five percent probability of a \$35 dollar per ton carbon tax reduces emissions by one quarter of the amount they would fall if the carbon tax was actually in place. However, the output cost of reducing emissions through expectations of future policy are considerably higher than the output cost of the carbon tax policy itself. This is because the potential costs of reallocating capital between energy producing technologies after the tax is implemented, such as from coal power plants to wind farms, along with the uncertainty depresses savings lowering the aggregate capital stock.