Working Paper: NBER ID: w15125
Authors: Gilbert E. Metcalf
Abstract: Cap and trade systems are emerging as the front-running policy choice to address climate change concerns in many countries. One of the apparent attractions of this approach is the ability to achieve hard limits on emissions over a control period. The cost of achieving this certainty on emission limits is price volatility. I discuss and evaluate various approaches within cap and trade systems to reduce price volatility. A fundamental trade-off exists between certainty of emission limits and price volatility. A pure carbon tax sacrifices certainty of emission limits in favor of price stability. I discuss how a hybrid carbon tax can be designed to achieve a balance between price stability and emissions certainty. This hybrid, dubbed the Responsive Emissions Autonomous Carbon Tax (REACT), combines the short-run price stability of a carbon tax with the long-run certainty of emission reductions over a control period.
Keywords: Climate Change; Cap and Trade; Carbon Tax; Price Volatility
JEL Codes: H23; Q4; Q54
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hybrid cap and trade systems (Q58) | reduce price volatility (G13) |
| hybrid carbon tax (REACT) (H23) | combine short-run price stability and long-run certainty of emissions reductions (E63) |
| REACT model (C59) | tax rate adjustments based on cumulative emissions (H23) |
| REACT model (C59) | mitigate risks associated with price volatility (G13) |
| REACT model (C59) | ensure compliance with emission targets (Q52) |
| price mechanisms (D47) | emissions behavior (Q52) |
| regulatory frameworks (G38) | market responses (D49) |
| firm expectations regarding future emissions policies (Q58) | emissions behavior (Q52) |
| safety valves (J28) | dampen price spikes (Q41) |
| safety valves (J28) | loosen emission caps (Q58) |
| traditional cap and trade systems (P18) | significant price volatility (G13) |