Price Regulation in Greenhouse Gas Emissions Cap-and-Trade Systems: From Theory to Policies
15 Pages Posted: 6 Mar 2010
Date Written: April 1, 2009
Abstract
Notwithstanding the infinite debate on price versus quantity instruments in the design of a global climate policy, Cap-and-Trade systems are dominating the policymakers' choices worldwide. This is a prime issue for the traditional equilibrium economics, which has argued that the structure of the costs and damages in climate change gives a strong presumption to price-type approaches, building on the seminal work of Weitzman (1974). Therefore, price regulation of Cap-and-Trade systems has been widely proposed as an efficient way to tackle cost uncertainty of abatement, which represents one of the main theoretical problems of using emissions trading. A further issue is the possible carbon price volatility. This paper reviews the theory behind different types of price cap systems and tries to highlight some insights for the existing and upcoming real world climate policies. The outcome is that a price cap alone, without a price floor, would prevent any Cap-and-Trade policy to reach the abatement target. Banking and borrowing are already available flexibility mechanisms through which combating the carbon price volatility. However, in dealing with price spikes, it might be useful to consider the possibility of linking a reserve allowance system with the access to certain types of offset credits.
Keywords: Emissions Trading, Cap-and-Trade, Price Caps and Floors, Allowance Reserve
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