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abrubptlknovember10 - Climate Policy when the Distant...

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Climate Policy when the Distant Future Matters: Catastrophic events with hyperbolic discounting Larry Karp Yacov Tsur November 10, 2006 Abstract We study climate change policy with hyperbolic discounting un- der the risk of catastrophic events. Using a binary action model, we compare the set of Markov Perfect Equilibria (MPE) to the optimal policy under (time consistent) commitment. For some initial condi- tions there are multiple MPE that may involve either excessive or insu cient stabilization e f orts relative to the policy under commit- ment. Numerical analysis shows that standard Integrated Assessment Models may have signi f cantly understated the optimal level of near- term e f ort to reduce GHG emissions. Even if the free-rider problem amongst contemporaneous decision-makers were solved, the coordina- tion problem amongst di f erent generations complicates the design of optimal policy. Keywords: abrupt climate change, event uncertainty, catastrophic risk, hyperbolic discounting, Markov Perfect Equilibria Department of Agricultural and Resource Economics, 207 Giannini Hall, University of California, Berkeley CA 94720 email:[email protected] Department of Agricultural Economics and Management, The Hebrew University of Jerusalem, P.O. Box 12 Rehovot 76100, Israel ([email protected]).
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1 Introduction Integrated Assessment Models (IAMs) — numerical models that combine cli- mate and economic modules — typically endorse modest near-term e f orts to reduce greenhouse gas (GHG) emissions (Nordhaus and Boyer 2000, IPCC 2001, Manne 2003, Edmonds and Sands 2003). These models have been in- f uential in guiding policy recommendations because of their empirical foun- dation. (See, for example, the open letters from economists to President Bush in the appendix to Gri n (2003), and the chapter on the Kyoto Protocol in Barrett (2003).) Although few of these models formally incorporate abrupt catastrophic events, discounting causes these events to have little e f ect on optimal climate policy (Mastrandrea and Schneider 2001). Low probability events (those with low hazard rates) are not likely to occur until the distant future, and discounting at a non-negligible rate makes the distant future al- most irrelevant to policy today. The conclusion that low-probability catas- trophic events are relatively unimportant for climate change policy probably sounds strange to the representative citizen (or climate scientist). We study catastrophic threats with hyperbolic discounting to provide another view of the importance of low probability climate events. Our main policy conclusion is that standard IAMs may signi F cantly understate the optimal reduction in GHG emissions. In reaching this conclusion, we show how to solve a new type of optimal control/dynamic game model, and we explain its relation to more familiar dynamic coordination problems.
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abrubptlknovember10 - Climate Policy when the Distant...

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