Seminar

On the efficient growth rate of carbon price under a carbon budget

Christian Gollier (Toulouse School of Economics)

October 8, 2018, 11:00–12:15

Toulouse

Room MS 003

Environment Economics Seminar

Abstract

When an intertemporal carbon budget is imposed to fight climate change, abating emissions earlier has a social rate of return that is equal to the growth rate of the marginal abatement cost, i.e., of the carbon price. I use a normative version of asset pricing theory to determine the efficient level of the growth rate of expected carbon price in this Hotelling’s framework under uncertainty. When future marginal abatement costs are negatively correlated with aggregate consumption, an immediate vigorous reduction in emissions provides a hedge against the macroeconomic risk borne by the representative agent. The growth rate of expected carbon price should therefore be smaller than the interest rate in that case, and the initial carbon price should be large. The opposite is true when this correlation is positive, and the Hotelling’s rule applies as a limit case with independence. We calibrate a simple two-period version of the model by introducing infrequent macroeconomic catastrophes à la Barro in order to fit the model to observed assets pricing in the economy. From this numerical exercise, we recommend a growth rate of expected carbon price around 3.5% per year (plus inflation), which is much larger than the 1% equilibrium interest rate in our economy.