Climate and the economy

John Hassler Per Krusell

The objective here is to show what a climate-economy model might look like and, based on such a model, calculate how high an optimal carbon dioxide tax should be under different assumptions of how future consumption is to be evaluated. Economic growth and welfare will be discussed on this basis.

sns_analys_nr_14.pdf 1.2 MB PDF

A CLIMATE-ECONOMY ANALYSIS IS NEEDED. Against a scientific background, it is concluded that humans affect the climate by using fossil fuel and that this effect on the climate does, on average, lead to non-negligible damage to the economy. In order to analyse how our economies might be expected to affect the climate in the future and to evaluate different kinds of climate policy, a climate-economy model is needed. To be able to work with such a model, a climate model, a carbon-cycle model as well as an economic model are needed. The objective here is to show what a climate-economy model might look like and, based on such a model, calculate how high an optimal carbon dioxide tax should be under different assumptions of how future consumption is to be evaluated. Economic growth and welfare will be discussed on this basis.

EIGHT POINTS ON THE CLIMATE AND THE ECONOMY
1. The burning of fossil fuel leads to a warmer climate, but it is uncertain how much warmer it will be.
2. According to available, but uncertain, calculations, the possible costs that are related to climate changes will be considerable, but do not constitute any catastrophe from a global perspective.
3. There exists no knowledge for making a reasonable estimate of the risks for unlikely, but potentially possible, large global damage.
4. The costs that might be caused by climate change are very unevenly distributed. Some, typically poor, countries and regions run the risk of being hit by catastrophic damage.
5. The burning of fossil fuel creates an ”externality” that the market cannot deal with on its own. A global carbon dioxide tax is the best policy instrument for dealing with this.
6. Given the available estimates, the optimal carbon tax is modest and not higher than the Swedish one.
7. The introduction of a global carbon tax constitutes no threat to economic growth and welfare.
8. A tax on conventional oil does, in the best case scenario, have moderately positive climate effects. A tax on the use of coal and non-conventional fossil fuel with large extraction costs works, even if such a tax is only implemented at the regional level.

AUTHOR John Hassler is Professor of Economics at the Institute for International Economic Studies, Stockholm University. E-mail: john.hassler@iies.su.se.
Per Krusell is Professor of Economics at the Institute for International Economic Studies, Stockholm University. E-mail: per.krusell@iies.su.se.