How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks

Garth Heutel

No 11-8, UNCG Economics Working Papers from University of North Carolina at Greensboro, Department of Economics

Abstract: How should environmental policy respond to economic fluctuations caused by persistent productivity shocks? This paper answers that question using a dynamic stochastic general equilibrium real business cycle model that includes a pollution externality. I first estimate the relationship between the cyclical components of carbon dioxide emissions and US GDP and find it to be inelastic. Using this result to calibrate the model, I find that optimal policy allows carbon emissions to be procyclical: increasing during expansions and decreasing during recessions. However, optimal policy dampens the procyclicality of emissions compared to the unregulated case. A price effect from costlier abatement during booms outweighs an income effect of greater demand for clean air. I also model a decentralized economy, where government chooses an emissions tax or quantity restriction and firms and consumers respond. The optimal emissions tax rate and the optimal emissions quota are both procyclical: during recessions, the tax rate and the emissions quota both decrease.

Keywords: Climate change; Environmental policy (search for similar items in EconPapers)
JEL-codes: E32 Q54 Q58 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2011-03-08
New Economics Papers: this item is included in nep-dge, nep-ene, nep-env, nep-mac and nep-res
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Citations: View citations in EconPapers (16)

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Journal Article: How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ris:uncgec:2011_008

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