Optimal Carbon Pricing in General Equilibrium: Temperature Caps and Stranded Assets in an Extended Annual DSGE Model

49 Pages Posted: 28 Dec 2020

See all articles by Rick van der Ploeg

Rick van der Ploeg

University of Oxford

Armon Rezai

Vienna University of Economics and Business

Date Written: 2020

Abstract

The general equilibrium model developed by Golosov et al. (2014), GHKT for short, is modified to allow for additional negative impacts of global warming on utility and productivity growth, mean reversion in the ratio of climate damages to production, labour-augmenting technical progress, and population growth. We also replace the GHKT assumption of full depreciation of capital each decade by annual logarithmic depreciation. Furthermore, we allow the government to use a lower discount rate than the private sector. We derive a tractable rule for the optimal carbon price for each of these extensions. We then simplify the GHKT model by modelling temperature as cumulative emissions and calibrating it to Burke et al. (2015) damages. Finally, we consider how the rule for the optimal carbon price must be modified to allow for a temperature cap, and what this implies for stranded oil and gas reserves. We illustrate our analytical results with a range of optimal policy simulations.

JEL Classification: H210, Q510, Q540

Suggested Citation

van der Ploeg, Frederick and Rezai, Armon, Optimal Carbon Pricing in General Equilibrium: Temperature Caps and Stranded Assets in an Extended Annual DSGE Model (2020). CESifo Working Paper No. 8782, Available at SSRN: https://ssrn.com/abstract=3754673 or http://dx.doi.org/10.2139/ssrn.3754673

Frederick Van der Ploeg (Contact Author)

University of Oxford ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

Armon Rezai

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

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