Optimal Climate Change Policies When Governments Cannot Commit

This paper examines the optimal design of climate change policies in the context where governments want to encourage the private sector to undertake significant immediate investment in developing cleaner technologies, but the carbon taxes and other environmental policies that could in principle stimulate such investment will be imposed over a very long future. The conventional claim by environmental economists is that environmental policies alone are sufficient to induce firms to undertake optimal investment. However this argument requires governments to be able to commit to these future taxes, and it is far from clear that governments have this degree of commitment. We assume instead that governments cannot commit, and so both they and the private sector have to contemplate the possibility of there being governments in power in the future that give different (relative) weights to the environment. We show that this lack of commitment has a significant asymmetric effect. Compared to the situation where governments can commit it increases the incentive of the current government to have the investment undertaken, but reduces the incentive of the private sector to invest. Consequently governments may need to use additional policy instruments – such as R&D subsidies – to stimulate the required investment.

Future of the Clean Development Mechanism in Tackling Climate Change

Using a theoretical framework, we explain the impact of the Clean Development Mechanism (CDM) on emissions in Annex I and non-Annex I countries. We show that on one hand, emissions in the non-Annex I country decline because of abatement sponsored by the Annex I country under the CDM; on the other hand, emissions may increase because (i) the Annex I country increases emissions in its own country, and (ii) the non-Annex I country crowds out the bene ts from the CDM projects by increasing its domestic emissions. For the CDM to be e¤ective in reducing global emissions, we show that partial Certi ed Emissions Reduction credits should be given to the Annex I country that sponsors CDM projects in the non-Annex I country. We also suggest that the CDM Executive Board should not allow the CDM projects to be hosted by non-Annex I countries that are too conscious about their emission levels.

Dark Clouds or Silver Linings? Knightian Uncertainty and Climate Change

This paper examines the impact of Knightian uncertainty upon optimal climate policy through the prism of a continuous-time real option modelling framework. We analytically determine optimal intertemporal climate policies under ambiguous assessments of climate damages. Additionally, numerical simulations are provided to illustrate the properties of the model. The results indicate that increasing Knightian uncertainty accelerates climate policy, i.e. policy makers become more reluctant to postpone the timing of climate policies into the future.