Balancing cost and emissions certainty: an allowance reserve for cap-and-trade

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National Bureau of Economic Research, 2008 - Business & Economics - 28 pages
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On efficiency grounds, the economics community has to date tended to emphasize price-based policies to address climate change -- such as taxes or a "safety-valve" price ceiling for cap-and-trade -- while environmental advocates have sought a more clear quantitative limit on emissions. This paper presents a simple modification to the idea of a safety valve: a quantitative limit that we call the allowance reserve. Importantly, this idea may bridge the gap between competing interests and potentially improve efficiency relative to tax or other price-based policies. The last point highlights the deficiencies in several previous studies of price and quantity controls for climate change that do not adequately capture the dynamic opportunities within a cap-and-trade system for allowance banking, borrowing, and intertemporal arbitrage in response to unfolding information.

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