Optimal carbon pricing with fluctuating energy prices – emission targeting vs. price targeting

By Alkis Blanz, Ulrich Eydam, Maik Heinemann and Matthias Kalkuhl

http://d.repec.org/n?u=RePEc:pot:cepadp:51&r=dge

Prices of primary energy commodities display marked fluctuations over time. Market-based climate policy instruments (e.g., emissions pricing) create incentives to reduce energy consumption by increasing the user cost of fossil energy. This raises the question of whether climate policy should respond to fluctuations in fossil energy prices? We study this question within an environmental dynamic stochastic general equilibrium (E-DSGE) model calibrated on the German economy. Our results indicate that the welfare implications of dynamic emissions pricing crucially depend on how the revenues are used. When revenues are fully absorbed, a reduction in emissions prices stabilizes the economy in response to energy price shocks. However, when revenues are at least partially recycled, a stable emissions price improves overall welfare. This result is robust to different modeling assumptions.

Interesting topic. I always wondered whether there would be value in energy price smoothing through taxation. Also, looking at the political economy of carbon taxes, would it make sense to increase the latter while energy prices are declining rather than whenever the law kicks in?