Abstract
We study environmental policy in a stylized economy–ecology model featuring multiple deterministic stable steady-state ecological equilibria. The economy–ecology does not settle in either of the deterministic steady states as the environmental system is hit by random shocks. Individuals live for two periods and derive utility from the (stochastic) quality of the environment. They feature warm-glow preferences and engage in private abatement in order to weakly influence the stochastic process governing environmental quality. The government may also conduct abatement activities or introduce environmental taxes. We solve for the market equilibrium abstracting from public abatement and taxes and show that the ecological process may get stuck for extended periods of time fluctuating around the heavily polluted (low quality) deterministic steady state. These epochs are called environmental catastrophes. They are not irreversible, however, as the system typically switches back to the basin of attraction associated with the good (high quality) deterministic steady state. The paper also compares the stationary distributions for environmental quality and individuals’ welfare arising under the unmanaged economy and in the first-best social optimum.
Highlights
Given that stochastic fluctuation are a fact of life under both scenarios, in which world would you like to be born if you do not know the combination that you will face at birth? Would you like to live in the turbulent world of the market economy or would you prefer the system managed by a social planner? To provide some perspective on this question we present Fig. 10 which depicts expected lifetime utility at birth, t the PDFs Λyt for environmental, resulting in the quality, Qt, and market equilibrium and in the first-best social optimum
In this paper we have studied the interactions between the environment and the macroeconomic system employing a stochastic overlapping generations model of the Diamond-Samuelson type
In the social optimum the policy maker conditions the allocation at each time on the pre-existing capital intensity and environmental quality
Summary
4 we compute the stochastic (first-best) social optimum (SSO) that is chosen by a dynamically consistent social planner operating under the same degree of uncertainty as the public about future environmental quality Such a planner computes state-dependent policy functions for private and public abatement, consumption by young and old, the future capital intensity, and the deterministic part of future environmental quality. Evaluated for the average capital intensity, the policy function for public abatement is strongly decreasing in pre-existing environmental quality whilst the one for private abatement displays the opposite pattern. The particular policy rule we consider stipulates that public abatement is a downward sloping linear function of the pre-existing environmental quality To parameterize this function we fit a straight line though the relevant part of the SSO policy function evaluated at the average capital intensity. An on-line Supplementary Material document contains a number of appendices presenting technical details
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