Optimal Carbon Abatement in a Stochastic Equilibrium Model with Climate Change

Abstract

This paper studies a dynamic stochastic general equilibrium model involving climate change. Our model allows for damages on output resulting from global warming. We compare two approaches (level and growth rate impact) and provide results for both. Our calibration captures several effects of climate change and feedback effects on the temperature dynamics. In particular, we are able to match estimates of future temperature distributions provided in the fifth assessment report of the IPCC (2014). We solve for the optimal abatement policy and find that this policy is considerably state-dependent. We also study the effect of risk aversion and elasticity of intertemporal substitution. It turns out that risk aversion matters more if climate change has a level impact on output, whereas the elasticity of intertemporal substitution has a significant effect for both specifications. Similar results hold for the social cost of carbon.