First-and second-best allocations under economic and environmental uncertainty

Abstract

This paper uses a micro-founded DSGE model to compare second-best optimal environmental policy and the resulting allocation to first-best allocation. The focus is on the source and size of uncertainty, and how this affects optimal choices and the inferiority of second best vis-à-vis first best.

Environmental policy and macroeconomic dynamics in a new Keynesian model

“…The first row presents the response to an increase in productivity A t , which has a positive impact on output. Consistently with the results of Heutel (2012) and Angelopoulos et al (2013), we show that the optimal emissions tax is procyclical, being so able to mitigate the increase of emissions due to the expansion of output. Without this positive reaction of the emissions tax, in fact, emissions would be more procyclical than under the Ramsey allocation.…”

“…In a similar setup, Angelopoulos et al (2013) demonstrate that the Ramsey government finds it optimal to cut taxes in response to a negative productivity shock in order to stimulate the economy, while in response to an adverse pollution shock it increases taxes to finance abatement spending in the attempt to mitigate the negative effects on the environment.…”

“…6 In particular, the closest predecessors of our paper are those studying environmental policy in a DSGE framework. Prominent examples include Springborn (2011), Heutel (2012), Angelopoulos et al (2010Angelopoulos et al ( , 2013 who study environmental policy in RBC models. 7 In detail, Fischer and Springborn (2011) explore the macroeconomic performance of an emissions tax, an emissions cap and an intensity target in a RBC model in which production requires a polluting input, so that emissions abatement results from reductions in production in response to shocks and to the environmental policy regime put in place.…”

Emissions Pricing Policies and Business Cycles: Fixed vs. Variable Tax Regimes

“…The producer uses capital as the only production factor to produce final goods and services and the consumer derives utility from consumption of final goods u ( c t ). Like many other emissions reduction policy analyses (such as Kelly ; Heutel ; Angelopoulos, Economides and Philippopoulos ), labour is not included for simplicity since employment fluctuation is not the interest of this study. As a RBC model, output at each period y t can be affected by stochastic TFP a t .…”

GHG Emissions Control and Monetary Policy

“…2 In this respect, see the papers by Springborn (2011), Heutel (2012), Angelopoulos et al (2013) and Bosetti and Maffezzoli (2014) who conduct their analysis in real business cycle type models studying environmental regulation in the context of uncertainty. 3 Further, by introducing imperfect price adjustments and lack of perfect competition, Ganelli and Tervala (2011) develop a fully-fledged open economy New Keynesian model designed for the study of the international transmission of environmental policy shocks, while Annicchiarico and Di Dio (2015) develop a closed economy New Keynesian model to study the business cycle under alternative environmental policy regimes (i.e.…”