Policy ramp versus big bang:
optimal global mitigation policy
Economic consensus:
the bottom line
• “Virtually every activity directly or indirectly involves
combustion of fossil fuels, producing emissions of carbon
dioxide into the atmosphere.
• Single bottom line for policy: “correct this market failure by
ensuring that:
– all people, everywhere, and for the indefinite future
are confronted with a market price for the use of
carbon that reflects the social costs of their activities.”
Nordhaus et al. (2008)
Discounting – Ramsey equation
• Ramsey optimal growth model:
– central framework for thinking about dynamic investment decisions
– organizing principle for setting long-run discount rates
• The Ramsey equation holds in the welfare optimum
Utility(c)
low ƞ
high ƞ
• r = ρ + ƞ* g
 %chg U
 %chg c


 x %chg c 

ct ct+1
c:
consumption
– ρ: rate at which utility from consumption is discounted
– ƞ: How quickly marginal utility falls as consumption rises.
Discounting
• SR approach—prescriptive/normative
– r = ρ + ƞg = 0.1% + 1*1.3% = 1.4%.
• ρ: favors a “low” social rate of time preference = 0.1%
– Argument: the only ethical reason to discount future
generations is that they might not be there at all (e.g.
cataclysmic comet) [consistent with Frank Ramsey]
– Prob. of extinction: 0.1%/year
• g: growth rate of consumption ~ 1.3%;
• ƞ: elasticity of marginal utility of consumption = 1
– (intergenerational) inequality aversion: lower
• Nordhaus approach--descriptive/positive
• ρ = 1.5% (assumed, Nordhaus 2008, p. 51)
• ƞ = 2 (calibrated, given r, ρ and g)
– (intergenerational) inequality aversion: higher
• r = 6.5% in 2015, falls over time to 4.5% in 2095 as g falls
(in DICE 2007, Arrow et al. 2012)
Comparison of the discount rate
Discount weight under various assumptions
1
Stern, r = 1.4%
Nordhaus, r=4.5%
0.9
Discount weight
0.8
0.7
0.6
The level at any given time t
represents the weight given to
consumption arriving at year t.
0.5
0.4
0.3
0.2
0.1
0
0
20
40
60
80
100
t
120
140
160
180
200
Damages
SR used a
level of GHG
damage at
the high end
of the
expected
range.
Nordhaus
(2008, p. 51)
• The ratio of aggregate damages to the size of
the economy ($D/$GDP) 100 years from now
• commonly assumed: 1-4%. (Weitzman, 2007)
• SR: >= 5%
Some conclusions
• Weitzman (2007): `On the political side … my
most-charitable interpretation of (the Stern
Review’s) urgent tone is that the report is …
– an essay in persuasion…
– that is more about gut instincts regarding the horrors
of uncertain rare disasters whose probabilities we do
not know…
– than it is about (conventional) economic analysis.
• SR might be right (“act now”) for the wrong
reasons (due to bad model parameters instead
of a careful analysis of uncertainty).’
The role of uncertainty in climate
change policy—Weitzman (2009)
• What happens to expected utility-based
BCA for fat-tailed disasters?
– Can “turn thin-tail-based climate-change
policy on it’s head” (p. 2).
• Concretely: a fat-tailed distribution over a
climate sensitivity parameter (S) which
maps CO2 changes into temperature
changes.
• Can drive applications of EU theory more
than discounting (p. 5).