NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Cost Containment in Climate Change Policy: Alternative Approaches to Mitigating Price Volatility

Gilbert E. Metcalf

NBER Working Paper No. 15125
Issued in July 2009
NBER Program(s):   EEE   PE

Cap and trade systems are emerging as the front-running policy choice to address climate change concerns in many countries. One of the apparent attractions of this approach is the ability to achieve hard limits on emissions over a control period. The cost of achieving this certainty on emission limits is price volatility. I discuss and evaluate various approaches within cap and trade systems to reduce price volatility. A fundamental trade-off exists between certainty of emission limits and price volatility. A pure carbon tax sacrifices certainty of emission limits in favor of price stability. I discuss how a hybrid carbon tax can be designed to achieve a balance between price stability and emissions certainty. This hybrid, dubbed the Responsive Emissions Autonomous Carbon Tax (REACT), combines the short-run price stability of a carbon tax with the long-run certainty of emission reductions over a control period.

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Document Object Identifier (DOI): 10.3386/w15125

Published: "Cost Containment in Climate Change Policy: Alternative Approaches to Mitigating Price Volatility," University of Virginia Tax Review , 29:2 (2009): 381 – 405.

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