Carbon Taxes and Climate Commitment with Non-constant Time Preference

Abstract

We study the Markov Perfect Equilibrium in a dynamic game where agents have non-constant time preference, decentralized households determine aggregate savings, and a planner chooses climate policy. The paper is the first to solve this problem with general discounting and general functional forms. With time-inconsistent preferences, a commitment device that allows a planner to choose climate policy for multiple periods is potentially very valuable. Nevertheless, our quantitative results show that while a permanent commitment device would be very valuable, the ability to commit policy for “only” 100 years adds less than two percent to the value of climate policy without commitment. We solve a log-linear version of the model analytically, generating a formula for the optimal carbon tax that includes the formula in Golosov et al. (2014) as a special case. More importantly, we develop new algorithms to solve the general game numerically. Convex damages lead to strategic interactions across generations of planners that lower the optimal carbon tax by forty-five percent relative to the scenario without strategic interactions.

Stranded Assets, the Social Cost of Carbon, and Directed Technical Change: Macroeconomic Dynamics of Optimal Climate Policy

“…Third, Engström and Gars (2015) allow for climate tipping in the GHKT model and argue that the anticipation of such tipping points accelerates fossil fuel extraction and global warming in the short run. Fourth, Iverson (2014) and Gerlagh and Liski (2015a) introduce hyperbolic discounting in the GHKT model. Finally, Li et al (2016) apply robust stochastic control techniques developed by Hansen and Sargent (2007) to the GHKT model to analyse robust policies for fighting climate change.…”

Discounting and Climate Policy

“…Others use the hyperbolic discounting framework put forward by Laibson (1977) and Krusell and Smith (2003) to analyse climate policy (e.g. Karp, 2005;Karp and Tsur, 2011;Iverson and Karp, 2017;Gerlagh and Liski, 2018). For example, Iverson and Karp (2017) study the Markov-perfect equilibrium to a dynamic game where private agents choose savings and policy makers decide on climate policy.…”

“…Karp, 2005;Karp and Tsur, 2011;Iverson and Karp, 2017;Gerlagh and Liski, 2018). For example, Iverson and Karp (2017) study the Markov-perfect equilibrium to a dynamic game where private agents choose savings and policy makers decide on climate policy. They show that with hyperbolic discounting, convex damages give rise to significant strategic interactions across generations of planners.…”

Provision of a Public Good with Altruistic Overlapping Generations and Many Tribes

“…In this case, the planner's optimal policy is state-dependent, and in general not a dominant strategy. Iverson (2013) shows, for the discrete-time log-linear model with investment and  = 1, that the first period action of a planner who can commit does not depend on her beliefs about future state-independent actions; this first period action equals the constant policy in a state-independent MPE. Phelps and Pollack (1968) obtain this result for a simpler model.…”