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Taxing fossil fuels under speculative storage

Semih Tumen (), Deren Unalmis, Ibrahim Unalmis () and Filiz Unsal ()

Energy Economics, 2016, vol. 53, issue C, 64-75

Abstract: Long-term environmental consequences of taxing fossil fuel usage have been extensively studied in the literature. However, these taxes may also impose several short-run macroeconomic policy challenges, the nature of which remains underexplored. This paper investigates the mechanisms through which environmental taxes on fossil fuel usage can affect the main macroeconomic variables in the short-run. We concentrate on a particular mechanism: speculative storage. Formulating and using a dynamic stochastic general equilibrium (DSGE) model, calibrated for the United States, with an explicit storage facility and nominal rigidities, we show that in designing environmental tax policies it is crucial to account for the fact that fossil fuel prices are subject to speculation. The existence of forward-looking speculators in the model improves the effectiveness of tax policies in reducing fossil fuel usage. Improved policy effectiveness, however, is costly: it drives inflation and interest rates up, while impeding output. Based on this tradeoff, we seek an answer to the question how monetary policy should interact with environmental tax policies in our DSGE model of fossil fuel storage. We show that, in an environment with no speculative storers, monetary policy should respond to output along with CPI inflation in order to minimize the welfare losses brought by taxes. However, when the storage facility is activated, responding to output in the monetary policy rule becomes less desirable.

Keywords: Fossil fuel; Environmental taxes; Speculative storage; DSGE (search for similar items in EconPapers)
JEL-codes: E31 E52 H23 O44 (search for similar items in EconPapers)
Date: 2016
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Working Paper: Taxing Fossil Fuels under Speculative Storage (2015) Downloads
Working Paper: Taxing Fossil Fuels under Speculative Storage (2014) Downloads
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DOI: 10.1016/j.eneco.2014.12.017

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Energy Economics is currently edited by R. S. J. Tol, Beng Ang, Lance Bachmeier, Perry Sadorsky, Ugur Soytas and J. P. Weyant

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