The Welfare Cost of Stabilization Targets

• Departmental Seminar
• Environmental and Resource Economics Workshop

Date and Location

Friday, April 18, 2014, 12:10 PM - 1:30 PM
ARE Conference Room, 2102 Social Sciences and Humanities

Abstract

We study stabilization targets: common environmental policy recommendations that specify maximum probability of an environmental variable exceeding a fixed target (e.g. limit climate change to at most two degrees C above preindustrial). An emissions policy (e.g. greenhouse gas emissions abatement) affects the environmental variable. Previous work generally considers stabilization targets under certainty equivalence. Using an integrated assessment model with uncertainty about the sensitivity of the temperature to greenhouse gas (GHG) concentrations (the climate sensitivity), learning, and random weather shocks, we calculate the optimal GHG emissions policy with and without stabilization targets. We characterize the range of feasible targets and show that the optimal constrained emissions abatement policy is sensitive to the target if the climate is more sensitive than expected. In general we show that climate change has far too much uncertainty and inertia to be controlled to the degree implied by stabilization targets: for most of the range of uncertainty, the target becomes either non-binding or infeasible.

We calculate the welfare cost of stabilization targets. We find that the stabilization targets have three welfare costs. First, the targets are inflexible and do not adjust to new information about the climate system. Second, the target forces the emissions policy to overreact to transient shocks. Third, the stabilization target may be lower than the unconstrained optimum under certainty. Total welfare costs are on the order of 5%, of which one quarter is caused by inflexibility and overreaction, effects present only in a model with uncertainty.