Climate Policy when the Distant Future Matters: Catastrophic Events with Hyperbolic Discounting

Abstract:     

Low probability catastrophic climate change can have a significant influence on policy under hyperbolic discounting. We compare the set of Markov Perfect Equilibria (MPE) to the optimal policy under time-consistent commitment. For some initial levels of risk there are multiple MPE; these may involve either excessive or insufficient stabilization effort. These results imply that even if the free-rider problem amongst contemporaneous decision-makers were solved, there may remain a coordination problem amongst successive generations of decision-makers. A numerical example shows that under plausible conditions society should respond vigorously to the threat of climate change.

Number of Pages in PDF File: 44

Keywords: abrupt climate change, event uncertainty, catastrophic risk, hyperbolic discounting, Markov Perfect Equilibria

JEL Classification: C61, C73, D63, D99, Q54