Policy ramp versus big bang: optimal global mitigation policy

1. Policy ramp versus big bang:optimal global mitigation policy

2. 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)

3. 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 • r = ρ + ƞ *g • ρ: rate at which utility from consumption is discounted • ƞ: How quickly marginal utility falls as consumption rises. Utility(c) low ƞ social rate of time preference elasticity of marginal utility of consumption real return on capital growth rate of consumption high ƞ ct ct+1 c: consumption

4. Discounting • SR approach—prescriptive/normative • r = ρ + ƞg = 0.1% + 1*1.3% = 1.4%. • ρ: favors a “low” social rate of time preference = 0.1% • Argument: the only ethical reason to discount future generations is that they might not be there at all (e.g. cataclysmic comet) [consistent with Frank Ramsey] • Prob. of extinction: 0.1%/year • 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, ρand 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)

5. Comparison of the discount rate Discount weight under various assumptions The level at any given time t represents the weight given to consumption arriving at year t. Discount weight

6. Damages 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% Nordhaus (2008, p. 51)

7. 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).’

8. 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 CO2 changes into temperature changes. • Can drive applications of EU theory more than discounting (p. 5).