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Optimal Intensity Targets for Greenhouse Emissions Trading Under Uncertainty

Frank Jotzo () and John Pezzey ()

Economics and Environment Network Working Papers from Australian National University, Economics and Environment Network

Abstract: Uncertainty is an obstacle for commitments under cap and trade schemes. We assess how well intensity targets, where countries' permit allocations are indexed to future realised GDP, can cope with uncertainties in international greenhouse emissions trading. We present some empirical foundations for intensity targets and derive a simple rule for the optimal degree of indexation to GDP. Using an 18-region simulation model of a cooperative, global cap-and-trade treaty in 2020 under multiple uncertainties and endogenous commitments, we show that optimal intensity targets could reduce the cost of uncertainty and achieve significant increases in global abatement. The optimal degree of indexation to GDP would vary greatly between countries, including super-indexation in some advanced countries, and partial indexation for most developing countries. Standard intensity targets (with one-to-one indexation) would also improve the overall outcome, but to a lesser degree and not in all individual cases. Although target indexation is no magic wand for a future global climate treaty, gains from reduced cost uncertainty and the potential for more stringent environmental commitments might justify the increased complexity and other potential downsides of intensity targets.

Keywords: climate policy; emissions trading; uncertainty; flexible targets; intensity targets; optimality; simulation modelling (search for similar items in EconPapers)
JEL-codes: Q00 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2006-08
New Economics Papers: this item is included in nep-ene, nep-env and nep-res
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