Abstract
The paper analyzes the effects of varying climate impacts on the social cost of carbon and economic growth. We use polynomial damage functions in a model of an endogenously growing two-sector economy. The framework includes nonrenewable natural resources which cause greenhouse gas emissions; pollution stock harms capital and reduces economic growth. We find a big effect of the selected damage function on the social cost of carbon and a significant impact on the growth rate. In our calibration a quartic damage function raises the social cost of carbon by more than a factor of ten compared to the linear function. In the social optimum the growth rate remains positive even when the damage function is highly convex. We test the robustness of the results by adding pollution decay, lowering the elasticity of intertemporal substitution, and addressing uncertainty, which does not alter our results. We find that high marginal climate damages require stringent climate policies but do not preclude positive economic growth despite convexity, provided that policies are designed in an efficient manner.
Highlights
1.1 Climate ImpactsThere is broad agreement that climate change has widespread effects on the economy and the natural environment
The paper shows that the choice of a specific climate damage function has a big impact on optimal climate policy and economic growth
We derive the effects of different damage functions on the social cost of carbon and the growth rate of the economy for various model specifications
Summary
There is broad agreement that climate change has widespread effects on the economy and the natural environment. Most economic models use constant or quadratic functions for climate damages so that a specific threshold temperature does not emerge and optimum warming can exceed the ceiling, depending on the benefits of climate policy. We find a big effect of the damage function on the social cost of carbon and a significant impact on the economic growth rate. If climate policies aiming to correct the pollution externality are sub-optimally chosen, damages to capital become higher and the economic growth rate may become negative in the long run.. Calibrating our model, we confirm that in the social optimum economic growth rates are still positive in the long run even for highly convex damage functions and assuming non logarithmic utility, i.e. for a quartic damage function and a low intertemporal elasticity of consumption substitution. A quartic damage function raises the social cost of carbon by more than a factor of ten compared to the linear function, already after 14 years.
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