Transcript Giblin LEcture

The Monetary Policy Approach to
Climate Policy Design
Warwick J. McKibbin
CAMA, Australian National University
& The Brookings Institution, Washington DC
Prepared for Singapore Economic Review Conference 07 August 2009
Overview
• Climate Science and Policy
• How to build a global framework
– Lessons from Kyoto
– Lessons from the financial crisis
• Key issues in the design of a global
system
• The McKibbin Wilcoxen Hybrid
• Conclusion
Bathtubs
• What matters for the climate are the
concentrations of greenhouse gases in
the atmosphere
• Concentrations are the accumulation of
greenhouse gas emissions from all
sources over time less sinks
• The exact flow of greenhouse gas in
any year is irrelevant relative to
stabilizing concentrations
Climate Science
• “Science” does not tell us exactly what
the global concentration target should
be - but it guides us
Climate Science
• Even if we knew the concentration
target “Science” does not tell us which
of the many paths for global emissions
should be followed for a given
concentration target
Climate Science
• Even if we knew the optimal path for
global emissions “Science” has nothing
to say about what target an individual
country should follow
Economics of Climate Change Policy
• Find the lowest cost distribution of
emission reductions globally to achieve
a global concentration target
– this will not be an equal proportional reduction
for each country
• But how to do this is practice?
What is Needed
• A change in the behaviour of energy
users and other greenhouse gas
emitters
• Technologies to
– reduce greenhouse gas emissions
– reduce energy demand
– increase energy efficiency
• Need to get the prices right
The Role of a Price on carbon
• The long term carbon price drives technology
and is an opportunity
– Demand side management
– The emergence of alternative technologies
– The adoption and diffusion of alternative technologies
• The short term carbon price is an input cost
and is an economic loss
How to build a global system?
Alternative Philosophies
(top down vs bottom up)
• Negotiate a global system in a common
framework from the top down
– The Kyoto approach
• Created a global system by coordinating
national policies to build a global system
– Nordhaus coordinated carbon tax
– The McKibbin-Wilcoxen Hybrid
Alternative Philosophies
(quantity vs price targets)
• IDEA - Pick an emissions target based on the
expected costs and expected benefits
– Targets and timetables (politically popular)
– Stern and Garnaut
• POLICY – “Cap and Trade” - Require firms have a
permit each year (based on a target) for each unit of
emissions with emissions capped
– Trade permits in the market
– Revenue goes to permit owner
– Emissions certain (targets and timetables) but cost is uncertain
• Global REGIME – join emission trading systems
together to generate a global price
Alternative Philosophies
(quantity vs price targets)
• IDEA - Pick a carbon price based on how much
society is willing to pay for insurance against climate
change and adjust the price over time as more
information is revealed
• National POLICY – “carbon tax” where firms are
charged a preannounced tax for each unit of carbon
emissions
– Revenue goes to the government
– Emissions uncertain but cost (i.e. the tax) is certain
• Global REGIME – set the same price everywhere
Alternative Philosophies
(quantity vs price targets)
• IDEA - Create a flexible system with long term
concentration targets to tie down credibility but
control the short term carbon price with flexibility as
we learn about costs and benefits
• National POLICY - Create a Hybrid system of long
term permit trading and short term carbon taxes
similar to the monetary policy framework with long
term carbon prices determined by a long term
concentration target but short term carbon prices
controlled by a central bank of carbon.
• Global REGIME – set the same price everywhere
Lessons from Kyoto Experience
• A system of rigid targets and timetables
is difficult to negotiate because it is a
zero sum game
• It is problematic for countries to commit
to a rigid target for emissions under
uncertainty about costs
• Even the most dedicated countries may
be unable to meet their targets due to
unforeseen events out of their control
Figure 1: Comparison of Projections of Energy Consumption, China
(Quadrillion(1015) Btu)
200
Reference Case
(EIA 2002)
160
High Economic
Growth Case
(EIA 2002)
Projection
History
120
Low Economic
Growth Case
(EIA 2002)
80
Reference Case
(EIA 2007)
40
High Economic
Growth Case
(EIA 2007)
0
1990
1995
2000
2005
2010
2015
2020
2025
2030
Note: The base years for projections reported in EIA 2002 and 2007 are 1999 and 2004, respectively.
Source: Energy Information Administration / International Energy Outlook 2002 and 2007
Low Economic
Growth Case
(EIA 2007)
Why there will not be a global carbon
trading market
• There will never be a global market for
permits because permits are like money –
they are the promise of a government to hit
an emission target
• Governments have widely different degrees
of credibility and national institutions are
vastly different across countries
Lessons from the Financial Crisis
• Expected costs and benefits of a policy
should not rely on our ability to forecast
• Critical to get global and national governance
and regulatory systems right
• Shocks will occur and some firewalls between
national climate policy systems is critical to
minimize volatility of the global system
Principles of Climate Change Policy Design
• Need to enable households and firms
in each country to manage the risks
associated with climate change
• Should be credible, flexible and able to
withstand future shocks
How to achieve credibility and flexibility
• Need long term property rights over carbon in
the hands of private agents
• Need an independent national central bank of
carbon to administer the policy with clear
goals
• Need clear short term price control
mechanism that enable costs to be smoothed
• Need to avoid reliance on foreign markets to
smooth domestic prices – can also increase
volatility
• Need fire walls around national systems
How do you actually build a monetary
style national climate policy?
McKibbin Wilcoxen Hybrid
• Aim
– Impose a long term carbon goal for the world
and distribute across economies
– Generate a credible long term price for carbon
in each country to guide energy related
investment decisions
– Keep short term costs low
– Provide a way for corporation and households
to manage climate risk
– Each country adopts nationally and cooperate
globally
Components of the Policy - 1
• Long-term permits (like a long term bond)
– A bundle of annual permits with different dates for each
permit and which expire on that date
– Quantity of permits over time is the long run goal
– Supply is fixed (and diminishing) and allocated to
households and industry
– Traded in a market with a flexible price
– NOT tradable across countries
2099
2096
2093
2090
2087
2084
2081
2078
2075
2072
2069
2066
2063
2060
2057
2054
2051
2048
2045
2042
2039
2036
2033
80
2030
2027
90
2024
2021
2018
2015
2012
CO2 Emission
Long Term Emission Permit
100
Current Emissions = 100
2020
2030
70
2050
60
50
40
30
20
10
0
Why long term permits?
• Lock in long term goal
• Provide financing on the balance sheets
of industry and households
– Not provided by a tax or a permit auction (how
do you pay for the technologies for abatement
and adaptation? Apply to a bureaucrat?)
• Act as a constraint on backsliding by
governments by valuing the credibility of
the policy where the assets are held by
the voters
Components of the Policy - 2
• Annual permits
– Must be acquitted against carbon emissions in
the year of issue
– Expire in year of issue
– Elastic supply from a central bank of carbon
(CBC) or limited international trade
– Price fixed for five years and then reset given
information available
– Act as a “safety valve” to cap the cost each year
but adjusted over time to hit the target
Short term Carbon price
• In any year companies will use a mix of
an annual coupon from the long term
permit and annual permits printed by
the CBC for a fixed price to satisfy their
emissions
• The price of permits in any year will be
fixed at the price of the annual permits
(effectively a carbon tax)
• The long term carbon price is
determined in a market
Climate policy as monetary policy
• Monetary Policy
– Target is inflation
over the cycle
– Short term target is the
cash rate
– Key driver of
economic activity is
expected future
interest rates (long
term bond rates)
– Cooperate with other
countries through
international BIS/IMF
• Climate Policy
– Target is
concentrations of
greenhouse gases
– Short term target is
the carbon price
– Key driver of
emissions is expected
future carbon prices
(price of long term
carbon asset)
– Cooperate with other
countries through the
UNFCCC processes
A Hypothetical Illustration
Fig 1: Long Term Permits in Annex B country
100
Emission/allocations
80
60
40
20
0
2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
-20
long term permits
Fig 2: Emissions and Long Term Permits
120
Emission/allocations
100
80
60
40
20
0
2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
-20
long term permits
actual emissions
safety valve price reset
20
06
20
14
20
19
20
24
20
29
20
34
20
39
20
44
20
49
20
54
20
59
20
64
20
69
20
74
20
79
20
84
20
89
20
94
20
99
21
04
$US 2002
Figure 3 : Annual Permit Price
160
140
120
100
80
60
40
20
0
Figure 4 : Stylized Value of Long Term Permits
(Assuming r=5%)
3000
2000
1500
1000
500
05
21
99
20
93
20
87
20
81
20
75
20
69
20
63
20
57
20
51
20
45
20
39
20
33
20
27
20
21
20
15
20
06
0
20
$US 2002
2500
Coordination of National Markets
US
Japan
P
EU
Australia
• Independent but coordinated via fixed
annual carbon price (P)
Key Issues Nationally
• Credible future price of carbon
– Hybrid pre committed target driving 100 year
yield curve
• Short term price volatility (spikes)
– Hybrid complete control for 5 year periods
Key Issues Nationally
• Financing change
– Hybrid puts revenue in the hands of innovators
in industry and households with any annual
permit sale revenue to finance R&D
• Balance Sheets
– Hybrid preserves corporate and household
balance sheets but changes the structure of
balance sheets
Stability
• Permits are like money
– Credibility of government is critical
• Firewalls are important to shield
domestic policy from foreign outcomes
• Domestic constituencies important
– Who benefits from regime withdrawal?
Key Issues Globally
• Incentives to negotiate
– The allocation of global targets is an allocation
of domestic revenue created by the carbon
constraint WITHIN economies between the
private sector and government. It is NOT a
transfer of revenue across countries
How to Bring in
Developing Countries ?
The MWH approach can be applied
in countries at different levels of
development
Developing Countries
• Negotiate a long term permit allocation
that is larger than current emissions
• Price of annual emission permits (or
economic cost) is zero in the short run
because more permits than needed
20
06
20
14
20
19
20
24
20
29
20
34
20
39
20
44
20
49
20
54
20
59
20
64
20
69
20
74
20
79
20
84
20
89
20
94
20
99
21
04
$US 2002
Figure 3 : Annual Permit Price
160
140
120
100
80
60
40
Annex B
China
20
0
Figure 4 : Stylized Value of Long Term Permits
(Assuming r=5%)
3000
2000
Annex B
1500
China
1000
500
05
21
99
20
93
20
87
20
81
20
75
20
69
20
63
20
57
20
51
20
45
20
39
20
33
20
27
20
21
20
15
20
06
0
20
$US 2002
2500
Trading Across Borders
• Developing country permits can enter
into the MWH national system but as
annual permits on a bilateral basis
• Cap on the amount determined until all
annual permits are used and CBC has
no revenue
Key Issues Globally
• Transfers to Developing Countries
– Partly through bilateral trade of annual permits
– Need to create a technology transfer policy and
development policies outside the carbon
markets so as to not complicate carbon pricing
with other objectives
Conclusions
• For any policy to survive it is critical to get
the balance between long run environmental
benefits and short run economic costs right.
• Flexibility, credibility and sustainability of the
policy framework are key
• Targets and timetables do not handle
uncertainty as well as price based systems
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