Tradable performance standards in a dynamic context

Abstract

Many sectors of the economy that are targets of emissions reduction policy exhibit price-responsive demand, long-lived capital, capacity constraints, and foresighted decision-making. I explore how these features affect the efficiency and dynamics of tradable performance standards (TPS) using analytical and numerical equilibrium models. While I show these dynamic considerations alone do not lead to conflicts with existing theory on the overall efficiency and cost-effectiveness of the TPS relative to a first-best policy, they do affect the transition path and steady state. Most notably, under all but the smallest discount rates, the TPS can lead to a more cost-effective post-transition steady state than the equivalent emissions cap. Given the intergenerational transition that comes with decarbonization, this result suggests some classes of present and future consumers may prefer a TPS to an emissions cap.