It seems to me that the most important feature of any climate policy should be adaptiveness. The climate is a complex dynamical system with the potential for unexpected behavior. The policy levers we have at our disposal should allow us to respond quickly to changes in state of the climate. It seems that an adaptive strategy for climate change requires making decisions similar to those faced by the Fed. At a very simple level, the Fed monitors the state of the economy and responds periodically with changes to interest rates to maintain inflation below a target level.
While much attention has been given to a “cap-and-trade system” as a way of pricing emissions, several well-known scholars, commentators, and leaders have recently expressed support for a carbon tax or pollution fee as more adaptive, providing markets greater certainty, and administratively simpler (Martin Wolf,Fareed Zakaria, Greg Mankiw and former Federal Reserve Chairman Alan Greenspan).
One big question I have is: Could a body like the Federal Reserve board–with as much independence and stature–monitor the state of the climate and adjust emissions fees (in some predictable way that markets could account for) to maintain the concentration of greenhouse gases in the atmosphere below a threshold? What other adaptive mechanisms exist for an emissions fee or cap-and-trade system?
Links
The Carbon Tax Center discusses carbon taxes in great detail.
Robert Lempert, Steven Popper, Steve Bankes, and others at RAND have written extensively about the importance of adaptiveness in policy design under deep uncertainty (e.g. Shaping the Next One Hundred Years: New Methods for Quantitative, Long-Term Policy Analysis and When We Don’t Know the Costs or the Benefits: Adaptive Strategies for Climate Change).
Update:
I failed to mention that the “adaptive” cap-and-trade alternative is adjusting the annual allocation. The adaptive carbon tax offers greater control over prices and the adaptive cap-and-trade system over quantity.
Unfortunately, most of the current bills on creating a cap-and-trade system do not provide for sufficiently adaptive mechanisms from the start, other than a safety valve on price and conditions for Congressional review. If Congress manages to pass any carbon pricing bill, I am not optimistic about the likelihood of Congress taking up this difficult issue again for quite some time. One doesn’t need to look any farther than the national debt to understand this.
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The question hinges on whether policy made at the national level would have a significant impact on the climate - or whether you would need a “global climate fed” to really have the impact. I know we get blamed for producing far more than our share of the greenhouse gases - and we do - but as a percent of the total, I don’t think it’s enough to solve the problem on its own. So I’m guessing it’d be more towards the later than the former.
Posted 30 Jun 2007 at 10:18 am ¶Doug,
Good point. I agree that global action is needed to really mitigate the potential for global warming. Such action can take the form of a fixed or adaptive carbon tax or cap-and-trade system.
I think the U.S. can lead by example by implementing some mechanism–preferably adaptive–for pricing carbon, in addition to initiating the lengthy negotiations needed for a global agreement. I have updated the post to reflect that the right parameter to target would be national emissions of greenhouse gases rather than global atmospheric concentration.
Posted 05 Jul 2007 at 6:28 pm ¶According to economic theory, there is a long term economic output that is a direct function of a national endowment of capital and labor. Whenever the economy’s GDP exceeds the output level, the economy adjusts back to optimal GDP, usually via inflation. Inflation about 4-5% or so, can be very disruptive and very painful for an economy. The Fed exists to temper domestic interest rates and inflation so that the economy can rest comfortably at its optimal output rate without fear of overheating.
Simply put, it exists to ensure a smooth ride to a long term equilibrium.
The problem with having a Fed-like body for air emissions is that there is no long term equlibirium for CO2 emissions to speak of, which makes it difficult to say what a high level of emission is.
That does not mean, however,that such a body should not exist. Detroit, where I am currently, is under a heat advisory; two weeks ago it was an “Ozone action day” which asked consumers to hold of on gasoline until the pre-dawn or post-dusk hours.
These alerts are inplace to advise consumers on what to do in light of acute air pollution problems, such as smog and ozone, on contrast to global warming which is global, chronic condition. It is completely feasible that a dynamic pricing model comes into place which responds to acute pollution concers, where gasoline and electricity would cost more on days it would do more damage to the air.
It would be interesting to see if this system would be effective in reducing long term emissions, but its just a thought.
Posted 09 Jul 2007 at 2:11 pm ¶Devesh,
Posted 09 Jul 2007 at 2:51 pm ¶Climate science suggests provides a reasonable picture of historical greenhouse gas emissions. In addition, it provides a relationship between emissions and regional temperature and precipitation changes. Doesn’t that specify what a high level of emission is?
Vivek,
There are two issues at play:
1. How can we set the target CO2 emissions.
2. Once set, how can we ensure / assist the economy to reach that target amount.
My last post was concerned with the first issue, namely how a Fed like body could set the target emission quanitity. I agree that climate science does have a lot to offer on the issue of what a high level of emission is, and would play a large role in determining what the target level ought to be.
The main problem with figuring out what the target emission quanitity ought to be is that it seems like an arbitraty figure. Consider the following case.
Suppose that today the US emits 100 tons of CO2 a day (a made up number). We all agree that number is too high, but what should the target number be and why? What is the decision criteria that the e-Fed (environmental Fed) should use to set that optimal amount? Further more, does the target level change over time, and if so why?
In the financial analogy, if the current rate of inflation is 9%, and interest rates are at 2%, then the Fed would raise interest rates to tame the inflation rate to a manegable 3% or so. The reason that the Fed, and hence financial markets, would know that interest rates should rise is because economic history dictates that when the economy is over producing, inflation increases. We also know that we can combat inflation via rising interest rates. Therefore, the combination of economic theory and histroy provide financial markets and the Fed with the knowledge to set interest rates that seem less arbitrary.
But your response did force be to re-think things, becase what I negelected to even think about, was that no matter what CO2 abatement strategy is used, a target level has to be determined at some point.
That brings me to point 2. I think that once the target level is set, the e-Fed would be much more simpler and straight-forward administratevely, to reach the target emission quantity.
Once the target emission quantity is set, it is a simple matter to figure out the gap between current emission and our target. The e-Fed could set the carbon-tax on a monthly basis and it would be directly proportional to the gap between emissions and our target.
So if January was a heavy month for emissions, then everyone would know that when February come around, the e-Fed will raise the carbon tax to get to the target level. I do think that a system like this would be simple, and provide the predictiablity that is desired. It also can spawn the creation of emission-futures and other exotic financial tools that can help corporation reduce carbon tax volatility.
Posted 10 Jul 2007 at 10:50 am ¶So the more I think about this, the more I think that I am being nit-picky about the whole “what the target ought to be” issue.
Setting the emissions target is a hugely political issue and it would make alot of sense to have a de-politizied body to it.
I think that appeal of having a fed-like body set the target is that they can balance the interests of economics and climate change better than an explicitly political body like Congress.
Posted 10 Jul 2007 at 11:08 am ¶If you are constantly readjusting, that takes away one of the main benefits of a tax vs a cap and trade.
In a world without uncertainty, a tax and cap and trade are mathematically equivalent. It is uncertainty that makes a tax preferable.
Also not sure I would trust decisions to be made by an independent body. Such decisions have huge consequences with huge uncertainties, and nebulous benefits like “setting an example for the world”. That is not something I would trust a political appointee to decide (unless it were me of course).
Posted 10 Jul 2007 at 2:43 pm ¶For those of you that know more about climate science / policy than I do, you can help me out.
I understand that global climate change itself is filled with uncertainties on virtually all dimensions. I also know that there is uncertainty on what a target emission output ought to be. What I do not understand, is the dynamic nature of this uncertainty over time.
That is, once we make a guess and set a target emissions output, how often would we change it? Several times a year? A decade? What drives the changing of the output level?
Posted 11 Jul 2007 at 9:44 am ¶My understanding is that the uncertainty is primarily based on lack of knowledge. So it is the pace of scientific/economic knowledge that dictates.
No particular reason it needs to be recalibrated too often. 5-10 years sounds about right. You need to give investors long lead time to reduce their uncertainty in planning.
Most government policies take a long time to recalibrate. (Like CAFE for example) That leads to small inefficiencies, but nothing substantial.
Posted 18 Jul 2007 at 10:18 am ¶Devesh,
I think the primary uncertainty in the target emissions level originates from our lack of understanding of the climate system. If we find that the climate has more positive feedback loops than expected and is heating up faster than our earlier models suggested, then we might need to recalibrate our policy.
I think Ben’s estimate of 5 years is good. That is about how often the IPCC updates its assessment . I also agree with Ben that signaling certainty to markets is crucial.
Ben,
I was surprised by your comment that
The Fed’s decisions do have huge consequences and huge uncertainties and my sense is that the Fed–and other independent bodies–have greater public trust than Congress.
Posted 16 Aug 2007 at 1:34 am ¶The Fed’s decisions do have huge consequences and huge uncertainties and my sense is that the Fed–and other independent bodies–have greater public trust than Congress.
Fair enough. But the Fed’s mandate at least is clear by statute. To minimize inflation and unemployment. The rest of what it does, the public is not qualified to decide.
It is not clear what the correct mandate should be in the context of climate change.
Posted 21 Aug 2007 at 2:30 pm ¶Post a Comment