Social time preference and the optimal carbon price

Abstract

This article examines the implications of alternative social time preference assumptions for the optimal carbon price by numerical simulations of a simple Ramsey model. Three specifications of social time preferences are compared: a constant social time preference rate (stpr), decreasing social impatience or hyperbolic social preferences and increasing social impatience. The results show nontrivial effects on the optimal carbon price. The policy implication is that value judgements about intergenerational welfare, reflected in stpr, have implications for policies aimed at achieving a target carbon price. These value judgements therefore ought to be made explicit in setting target carbon prices over time.

Notes

¹The inequality holds for any plausible parameterization, otherwise it would imply that the emissions damages from future output are so costly that it is not worth saving to increase future output.

²This is one potential cause for the so-called ‘carbon price ramp’ where the optimal carbon price starts out low and increases over time. In other models it can be because at the present time creating physical capital is more productive than using resources to reduce emissions, but over time the rising cost of emissions shifts this balance towards emissions reductions, implying a rising carbon price (Nordhaus, 2007).

³‘Virtually no difference’ means that they are an order of magnitude less. For example, if two alternative social time preference assumptions make a 20% difference to the carbon price at time t, then changing the production function parameters would typically yield the same 20% impact on the carbon price plus or minus a few percentage points.