A completely revised version of Three Reasons to Price Carbon under Uncertainty: Accuracy of Simple Rules” is now available at SSRN.
Compared to the previous version, we have made our perturbation-based solution method significantly more accessible to a general interest audience, completely revised our tipping point model, and implemented several new robustness checks. We show that our rule provides a very accurate approximation of the optimal SCC and that it can also be applied to a number of other models.
Abstract
An easy-to-interpret rule for the optimal risk-adjusted social cost of carbon is derived using perturbation analysis. This rule internalises the adverse effects of global warming on the risk of recurring climate-related disasters, the risk of irreversible cascading climate tipping points, and the usual effect on total factor productivity. It and its three components approximate the true numerical optimum well, especially if the small parameters (i.e., the share of damages in GDP, the sensitivity of the risk of disasters to temperature and the risk of climate tipping) are small enough and the discount rate is not too small. The rule is also accurate if applied to models with a different supply side, e.g., with ongoing technical progress in fossil-fuel production or multiple economic sectors. With a growth-adjusted discount rate of 2%/year, the SCC is $159/CO2, 75% of which is due to recurring climate disasters.
