Policy ramp versus big bang: optimal global mitigation policy

Economic consensus: the bottom line

• “Virtually

every activity

directly or indirectly involves combustion of fossil fuels,

producing emissions

of carbon dioxide into the atmosphere. •

Single bottom line

for policy: “correct this market failure by ensuring that: –

all people, everywhere, and for the indefinite future

are confronted with a

market price for the use of carbon

that reflects the social costs of their activities.” Nordhaus et al. (2008)

Discounting – Ramsey equation

• Ramsey optimal growth model: – central framework for thinking about dynamic investment decisions – organizing principle for setting long-run discount rates • The Ramsey equation holds in the welfare optimum Utility(c) low

ƞ

•

r

=

ρ

  +

ƞ *

%chg %chg c  

g

 %chg c 

c t c t+1

– –

ρ:

rate at which utility from consumption is discounted

ƞ:

How quickly marginal utility falls as consumption rises.

high

ƞ

c: consumption

Discounting

• SR approach—prescriptive/normative –

r

=

ρ

+

ƞg

= 0.1% + 1*1.3% = 1.4%.

•

ρ:

favors a “low” social rate of time preference generations is that – Prob. of extinction: 0.1%/year

=

0.1% – Argument: the only ethical reason to discount future

they might not be there at all

(e.g. cataclysmic comet) [consistent with Frank Ramsey] •

g:

growth rate of consumption ~ 1.3%; •

ƞ:

elasticity of marginal utility of consumption = 1 – (intergenerational) inequality aversion: lower • Nordhaus approach--descriptive/positive •

ρ =

1.5% (assumed, Nordhaus 2008, p. 51) •

ƞ = 2

(calibrated, given

r, ρ

and

g

) – (intergenerational) inequality aversion: higher •

r =

6.5% in 2015, falls over time to 4.5% in 2095 as

g

falls (in DICE 2007, Arrow et al. 2012)

Comparison of the discount rate

Discount weight under various assumptions 1 0.9

Stern, r = 1.4% Nordhaus, r=4.5% 0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0 0 20 40 60 80 The level at any given time represents the weight given to consumption arriving at year 100 t 120 140 160 180 200

t t

.

Damages

Nordhaus (2008, p. 51) SR used a level of GHG damage at the high end of the expected range.

• The ratio of aggregate damages to the size of the economy ($D/$GDP) 100 years from now • commonly assumed: 1-4%. (Weitzman, 2007) • SR: >= 5%

Some conclusions

• Weitzman (2007): `On the political side … my most-charitable interpretation of (the Stern Review’s) urgent tone is that the report is … – an essay in persuasion… – that is more about gut instincts regarding the horrors of uncertain rare disasters whose probabilities we do not know… – than it is about (conventional) economic analysis.

• SR might be right (“act now”) for the wrong reasons (due to bad model parameters instead of a careful analysis of uncertainty).’

The role of uncertainty in climate change policy —Weitzman (2009)

• What happens to expected utility-based BCA for fat-tailed disasters? – Can “turn thin-tail-based climate-change policy on it’s head” (p. 2). • Concretely: a fat-tailed distribution over a climate sensitivity parameter (

S

) which maps CO 2 changes.

changes into temperature • Can drive applications of EU theory more than discounting (p. 5).