Presidential Address 2020: Suboptimal Climate Policy[“Climate Change Uncertainty Spillover in the Macroeconomy.”]

There is a scientific consensus that human activities, in the form of emissions of carbon dioxide into the atmosphere, cause global warming. These emissions mostly occur in the marketplace, that is, they are undertaken by private individuals and firms. Governments seeking to curb emissions thus need to design policies that influence market behavior in the direction of their goals. Economists refer to Pigou taxation as “the” solution here, since the case of global warming can be seen as a pure (negative) externality. We agree. However, given the reluctance of policymakers to agree with us, there is an urgent need to consider, and compare, suboptimal policies. In this paper, we look at one such instance: setting a global tax on carbon at the wrong level. How costly are different errors? Since there is much uncertainty about how much climate change there will be, and how damaging it is when it occurs, ex-post errors will most likely be made. We compare different kinds of errors qualitatively and quantitatively and find that policy errors based on over-pessimistic views on climate change are much less costly than those made based on over-optimism. This finding is an inherent feature of standard integrated assessment models, even though these models do not feature tipping points or strong linearities.