Carbon Prices for the Next Thousand Years

57 Pages Posted: 30 Jun 2012  

Reyer Gerlagh

Tilburg University - Center and Faculty of Economics and Business Administration

Matti Liski

Aalto University - Department of Economics

Date Written: June 28, 2012

Abstract

Climate is a persistent asset, bar none: changes in climate-related stocks have consequences spanning over centuries or possibly millennia to the future. To reconcile the discounting of such far-distant impacts and realism of the shorter-term decisions, we consider hyperbolic time-preferences in a climate-economy model. Time-changing utility discount rates have unexplored general-equilibrium effects: carbon prices exceed the pure carbon externality costs - the Pigouvian tax level - by multiple factors in our quantitative assessment. The climate-economy model is rich in details but can be solved in closed-form yielding Markov carbon prices dependent on climate system parameters, damage estimates, technology parameters, and both short- and long-term time preferences. The equilibrium time discount rate is endogenous, and it can justify high carbon taxes as advocated by Stern while maintaining the realism of the macroeconomic outcome, thus providing a solution for the dilemma centering the carbon tax-discount rate debate. The welfare ranking of the policy alternatives is unambiguous: enforcing the Pigouvian tax decreases a consistently-defined welfare measure vis-a-vis the Markov equilibrium.

Keywords: carbon tax, discounting, climate change, inconsistent preferences

JEL Classification: H430, H410, D610, D910, Q540, E210

Suggested Citation

Gerlagh, Reyer and Liski, Matti, Carbon Prices for the Next Thousand Years (June 28, 2012). CESifo Working Paper Series No. 3855. Available at SSRN: https://ssrn.com/abstract=2094928

Reyer Gerlagh (Contact Author)

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Matti Liski

Aalto University - Department of Economics ( email )

PO Box 1210
FI-00101 Helsinki
Finland
+358-9-43138384 (Phone)
+358-9-43138735 (Fax)

HOME PAGE: http://www.hkkk.fi/~liski

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