Optimal Emissions Reduction in ILA and OLG versions of RICE Model

Conclusions about the optimal reduction of greenhouse gas emissions are substantially dependent on discount rates, under which costs benefits analyses are evaluated. There is the international debate about appropriate discounting in policy analyses. If the future benefits discounted at a rate compatible with market real interest rates, the optimal reduction of GHG’s emissions should be moderate in the early period with more aggressive emission cuts later. But the use of high discount rates is inconsistent with classical utilitarianism, which holds that equal weight should be attached to the welfare of present and future generations. If the future benefits discounted at a low rate in the infinitely-lived agent framework, there should be the extreme immediate actions in emission reduction. But this assumption is not compatible with today’s real returns on capital and saving rates. In this paper we introduce an overlapping generation framework with seven generations in the RICE model of William D. Nordhaus. We consider competitive equilibrium where “global” government follows Ramsey type optimal policy and set emissions control rates maximizing utilitarian welfare function treating all generation in all regions equally. As we consider competitive equilibrium we avoid Negishi weighting and could specify and solve the model in a more natural way. The model provides two discount rates: the social planner discount rate under which costs benefits analyses of climate projects are evaluated and the market discount rate for investments in physical capital. By distinguishing the two discount rates it is possible to give each generation equal consideration while still allowing for individual impatience. So this framework is a natural way to separate equity and efficiency. Regional specification of the model allows us to investigate regional-specific policies and to analyze welfare gains and loses of different generations in different regions along optimal emissions reduction path in comparison to alternative policies. Under plausible calibration simulation results of the model indicate to a more radical global emissions reduction than in the original RICE model. Emissions control rates are very different across regions. Major beneficiaries from the RICE-OLG optimal policy are generations to be born in the poor countries in the next century.