To Build or Not to Build? Capital Stocks and Climate Policy

Abstract

We investigate how in dirty and clean capital stocks affects optimal climate policy, from both theoretical and numerical perspectives. An increasing carbon tax will reduce investments in assets that pollute, and so reduce emissions in the short term: our irreversibility effect. As such the Green Paradox has a converse if we focus on demand side capital stock effects. We also show that the optimal subsidy increases with the deployment rate: our acceleration effect. Considering second-best settings, we show that, although carbon taxes achieve stringent targets more efficiently, in fact renewable subsidies deliver higher welfare when policy is more mild.