Pricing Carbon and Adjusting Capital to Fend off Climate Catastrophes

Apr 2018 | 207

Authors: Rick Van der Ploeg Aart de Zeeuw

The optimal reaction to a potential productivity shock as a consequence of climate tipping is to substantially tax carbon in order to curb the risk of tipping, but to adjust capital as well in order to smooth consumption when tipping occurs. We also allow for conventional marginal climate damages and decompose the optimal carbon tax in two catastrophe components and the conventional component. We distinguish constant and increasing marginal hazards. Moreover, the productivity catastrophe is compared with recoverable catastrophes and with a shock to the climate sensitivity. Finally, we allow for investments in adaptation capital as an alternative to counter the potential adverse effects of climate tipping. Quantitatively, the results are investigated with a calibrated model for the world economy.

JEL Codes: D81, H20, O40, Q31, Q38

Keywords: climate tipping point, risk, social cost of carbon, precautionary capital, economic growth.

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