Optimal Carbon Abatement in a Stochastic Equilibrium Model with Climate Change

58 Pages Posted: 15 Mar 2015 Last revised: 13 Jul 2020

See all articles by Christoph Hambel

Christoph Hambel

Goethe University Frankfurt

Holger Kraft

Goethe University Frankfurt

Eduardo S. Schwartz

Simon Fraser University (SFU); University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

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Date Written: July 11, 2020

Abstract

This paper studies a dynamic stochastic general equilibrium model involving climate change.
Our framework allows for feedback effects on the temperature dynamics. We are able to match estimates of future temperature distributions provided in the fifth assessment report of the IPCC (2014). We compare two approaches to capture damaging effects of temperature on output (level vs. growth rate impact).It turns out that the choice of the damage function is crucial to answer the question of how much the distinction between level and growth rate impact matters. The social cost of carbon is similar for frameworks with level or growth rate impact if the potential damages of global warming are moderate (Nordhaus calibration). On the other hand, they are more than twice as large for a growth rate impact if damages are presumably severe (Weitzman calibration). We document that climate uncertainty delivers a major contribution to the social cost of carbon. In particular, different types of climate shocks amplify each other and give an additional boost to the social cost of carbon. This effect is especially pronounced if risk aversion is high and damages are highly convex. If damages are moderate for high temperatures, risk aversion only matters when climate change has a level impact on output, but the effects are relatively small. By contrast, the elasticity of intertemporal substitution has a significant effect for both level and growth rate impact.
If damages are potentially severe for high temperatures, then the results also become sensitive to risk aversion.

Keywords: Climate change economics, carbon abatement, social cost of carbon, GDP growth, stochastic differential utility

JEL Classification: D81, Q5, Q54

Suggested Citation

Hambel, Christoph and Kraft, Holger and Schwartz, Eduardo S., Optimal Carbon Abatement in a Stochastic Equilibrium Model with Climate Change (July 11, 2020). Available at SSRN: https://ssrn.com/abstract=2578064 or http://dx.doi.org/10.2139/ssrn.2578064

Christoph Hambel

Goethe University Frankfurt ( email )

Faculty of Economics and Business
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Holger Kraft (Contact Author)

Goethe University Frankfurt ( email )

Faculty of Economics and Business
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Eduardo S. Schwartz

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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