Adjustable emissions caps and the price of pollution

Cap and trade schemes often use a policy of adjustable allowance supply with the intention to stabilize the market for allowances. We investigate whether these policies deliver with a focus on allowance prices. Motivated by existing policies, we study schemes that rely on either the allowance price (price measures) or the surplus of unused allowances (quantity measures) to adjust supply in a dynamic cap and trade market. Compared to emissions trading under a fixed cap, we find that price measures stabilize allowance prices. Quantity measures can be destabilizing. Though phrased in the context of changing interest rates, our results warn more generally against the belief that quantity measures are a suitable instrument to promote a stable cap and trade market

Unraveling Coordination Problems

The interplay between strategic beliefs and policy complicates policy design in coordination games. To untangle this relationship, we study policy design in the context of equilibrium selection. We characterize the unique subsidy scheme that selects a targeted strategy vector as the unique equilibrium of a coordination game. These subsidies are continuous in model parameters and do not make the targeted strategies strictly dominant. While discrimination is optimal in games with multiple equilibria (Segal, 2003; Winter, 2004), we construct a non-discriminatory subsidy scheme the cost of which converges to that of a least-cost discriminatory policy when agents are symmetric

Time Horizons and Emissions Trading

We study dynamic cap-and-trade schemes in which a policy of adjustable allowance supply determines the cap on emissions. Focusing on two common supply policies, price and quantity mechanisms, we investigate how the duration of a cap-and-trade scheme affects equilibrium emissions under its cap. More precisely, we consider the reduction in equilibrium emissions realized by shortening the duration of the scheme. We present four main results. First, the reduction in emissions is positive and bounded from below under a price mechanism. Second, the reduction in emissions is bounded from above under a quantity mechanism. Third, these upper and lower bounds coincide when the price and quantity mechanism are similar. Fourth, we identify sufficient conditions for which the reduction in emissions is strictly negative under a quantity mechanism. We quantify our theoretical results for the European Union, the world’s largest cap-and-trade scheme to use a quantity mechanism; effects on cumulative EU emissions range from trivial to substantial

Climate Policy and Trade in Polluting Technologies

This paper studies international trade in equipment used in the combustion of fossil fuels. Informed by a theoretical analysis, we identify a type of technology leakage hitherto unexplored in the literature: a country’s export of combustion equipment tends to increase, all else equal, in the stringency of its climate policy. We test this prediction by estimating the impact of carbon pricing on international trade in combustion equipment using detailed data on bilateral trade and domestic carbon prices for the period 1995–2021. Our estimates reveal a robust positive association between the stringency of climate policies and exports of combustion equipment, providing clear evidence for the existence of technology leakage. We argue that standard policies to mitigate carbon leakage are unlikely to prevent technology leakage, raising novel policy questions

Regulating Global Externalities

The question in which we are interested is how a market inhabited by multiple agents, about whom we are differentially uncertain, and who trade goods the use of which imposes a negative effect on others, is to be ideally regulated. We show that a priori asymmetric uncertainty, when combined with a posteriori observed outcomes, is a rich source of information that can be used to reduce aggregate uncertainty. The observation implies that whereas asymmetric information usually entails a cost on welfare, it can help achieve greater efficiency in regulation

Unraveling Coordination Problems

Strategic uncertainty complicates policy design in coordination games. To rein in strategic uncertainty, the planner in this paper connects the problem of policy design to that of equilibrium selection using a global games approach. We characterize the subsidy scheme that induces coordination on a given outcome of the game as its unique equilibrium. Optimal subsidies are symmetric for identical players, continuous functions of model parameters, and do not make the targeted strategies strictly dominant for any of the players; these properties differ starkly from canonical results in the literature. Uncertainty about payoffs impels policy moderation as aggressive intervention might itself induce coordination failure. JEL codes: D81, D82, D83, D86, H20. Keywords: mechanism design, global games, contracting with externalities, unique implementation

An Endogenous Emission Cap Produces a Green Paradox

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On Environmental Externalities and Global Games

This dissertation investigates strategies to regulate environmental externalities. Chapter 1 studies the regulation of stock externalities under asymmetric information and future uncertainty. The chapter derives optimal tax and quota instruments that perform remarkably well, solving the asymmetric information problem almost entirely. This chapter also proves that an optimal tax policy converges to the hypothetical symmetric information outcome two orders or magnitude faster than an optimal quota policy. In contrast to the focus on novel policies in chapter 1, chapter 2 establishes two unintended yet undesirable side-effects of an existing policy. Due to a 2018 reform, the EU ETS features an endogenous cap on emissions. This chapter shows that, generally, such an endogenous emissions cap may lead to an increase in emissions in response to an anticipated future policy meant to reduce them. Moreover, discontinuities in the design of the EU ETS also introduce equilibrium multiplicity, exposing participating firms to additional uncertainty. Whereas chapters 1 and 2 study policies by a single policymaker, chapter 3 focuses on collaborations between independent policymakers regulating emissions in their own jurisdictions through a cap and trade scheme. The chapter shows that global welfare always increases after jurisdictions link their schemes and derives an optimal linkage. Though simple, the optimal linkage deviates substantially from existing policy proposals for linking. The final chapter uses the methodology of global games to study equilibrium selection in a coordination game where players must choose between clean and dirty technologies. The chapter also develops network subsidies. A network subsidy allows the policymaker to correct for the entire externality deriving from technological spillovers but does not, in equilibrium, cost the policymaker anything

Climate-conscious consumers and the buy, bank, burn program

Manipulation of European Union emission trading systems (ETS) by the buy, bank, burn program compensates unregulated emissions while regulated sectors carry a large part of the burden. This distorts the balance between regulated firms and non-regulated projects, so parties outside the EU ETS can be virtuous at the cost of others