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Environmental Economics: Carbon Prices for Next 1000 Years

Friday, June 07, 2013
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The pricing of carbon emissions needs to be sensitive to both long-run climate outcomes and short-term concerns about the macroeconomy. Research by Reyer Gerlagh and Matti Liski reconciles these two timeframes and comes up with optimal prices of between €20 and €130 per ton of carbon dioxide.

The essence of climate policy is a price for carbon emissions. The European Union’s Emission Trading Scheme (EU-ETS) provides an example, with prices around €20 per ton of emissions between 2005 and 2008, dropping to levels below €5 per ton recently.

Carbon emission allowances bought and sold within the EU emissions trading system which traded at over €30 before the recession, are currently trading at around €3.50, and only 7% of the value of what is believed to be necessary to shift economies onto a low carbon pathway (€47).

For their recommendations for climate policy, economists evaluate the social costs arising from climate change vis-à-vis the costs of reducing greenhouse gas emissions.

Compared with other environmental issues, the unusual feature of climate change is the delay between emissions and the impacts: current greenhouse gas emissions have climate change consequences spanning over centuries or possibly millennia into the future. This causes a serious problem for economic evaluation.

When economists evaluate future damages in a way that is consistent with other macroeconomic decisions, they heavily discount future consequences and ignore the majority of climate impacts. Yet, if they do not discount the far future climate change consequences, they must evaluate the future in a way that is inconsistent with other observed macroeconomic decisions.

This fundamental puzzle of climate change policy analysis has been fiercely debated over the past 20 years. Some economists emphasised that policy needs to respect the observed shorter-term time preferences consistent with historical consumption choices (and neglect far-future damages accordingly), while others argued for considerable weights on longer-term climate outcomes.

UK heavy industry could suffer as carbon prices stall

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