Living on the Edge of the Catastrophe

The aim of this paper is to provide a theoretical model in order to analyse environmental policy under uncertainty regarding the possibility of a natural disaster. We adopt a two-periods analytical model, to investigate two different institutional settings, one featuring a myopic social planner, choosing emissions in each time period to maximize current net bene?ts, and one featuring a forward-looking planner, who maximizes the expected net present value of welfare across the two periods. As in Barrett (2013), uncertainty regards a threshold pollution level that, if violated, triggers a natural disaster. We conclude that under a myopic social planner welfare may increase or decrease over time, while in a non-myopic scenario welfare always increases across periods. Also, our model supports the idea that a myopic social planner pushes emissions closer to the edge of the natural disaster, but then, if the latter does not take place in the ?rst period, bene?ts from having done that in terms of welfare in the second period. Introducing a stochastic decay rate, we also show that the environment may reward (punish) myopic behaviour ex post. Finally, the comparison between myopic and forward looking settings is not straightforward: this depends on a risk spreading vs. information learning trade off.