A Green-Golden Rule for Climate Policy

Abstract

Fiscal rules that limit government deficits address the problem of excessive public debt, but can have negative consequences for the provision of durable public goods. In a model with climate policy, we analyze the relationship between such deficit rules and emission reductions induced by climate policy. While deficit rules reduce excessive government debt, this comes at the expense of emission reductions. In contrast, a green--golden rule, inspired by the golden rule of fiscal policy, can induce both the efficient deficit and the efficient emission reductions. The rule links the admissible deficit to observed emissions or carbon prices and to the social cost of carbon. We illustrate admissible debt levels for a quantity- and a price version of the rule.
A cumulative decrease in emissions of 280 Mt CO2 between 2020 and 2030 would lead to an admissible cumulative deficit of around 160 Bn. Euro. Increasing the carbon price to 200 Euro/tCO2 in 2024 would grant additional fiscal space amounting to 0.3% of GDP per year to a government that could be spent unconditionally.
In comparison to the general golden rule, the green--golden version has decisive advantages when it comes to its practical implementation.

Keywords: Fiscal Rules, Climate Policy, Public Debt, Present Bias, Golden Rule of Fiscal Policy, Social Cost of Carbon