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

Garth Heutel

Review of Economic Dynamics, 2012, vol. 15, issue 2, 244-264

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. (Copyright: Elsevier)

Keywords: Climate change; Environmental policy (search for similar items in EconPapers)
JEL-codes: E32 Q54 Q58 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (298)

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DOI: 10.1016/j.red.2011.05.002

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