Pricing carbon and adjusting capital to fend off climate catastrophes

Working paper

The optimal reaction to a potential productivity shock as a consequence of climate tipping is to substantially tax carbon in order to curb the risk of tipping, but to adjust capital as well in order to smooth consumption when tipping occurs. We also allow for conventional marginal climate damages and decompose the optimal carbon tax in two catastrophe components and the conventional component. We distinguish constant and increasing marginal hazards. Moreover, the productivity catastrophe is compared with recoverable catastrophes and with a shock to the climate sensitivity. Finally, we allow for investments in adaptation capital as an alternative to counter the potential adverse effects of climate tipping. Quantitatively, the results are investigated with a calibrated model for the world economy.

Authors: Van der Ploeg, R; de Zeeuw, A

• Publication status: Published
• Publisher: University of Oxford
• Series: OxCarre Papers
• Publication date: 2018-04-02
• Paper number: 207
• Keywords: risk; precautionary capital; economic growth; social cost of carbon; climate tipping point