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June 24, 2010

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"The Real Options for U.S. Climate Policy"

Posted: 24 Jun 2010 01:17 AM PDT

Robert Stavins says climate change legislation is still possible and, after an extensive review of all the "real options for climate policy in the United States," he concludes that the best available alternative is an economy-wide cap-and-trade system. (It's hard for me to envision an economy-wide cap-and-trade system finding the political support it needs to be enacted, but I hope I'm wrong. This is quite a bit shorter than the original and, in addition, the original is dense with links to supporting documentation.):

The Real Options for U.S. Climate Policy, by Robert Stavins: The time has not yet come to throw in the towel regarding the possible enactment in 2010 of meaningful economy-wide climate change policy...  Meaningful action of some kind is still possible, or at least conceivable.  But with debates regarding national climate change policy becoming more acrimonious in Washington as midterm elections approach, it is important to ask, what are the real options for climate policy in the United States – not only in 2010, but in 2011 and beyond.  That's the purpose of this essay.
Federal Policy Options Let's begin my considering Federal policy options under two distinct categories:  pricing instruments and other approaches.  Carbon-pricing instruments could take the form of caps on the quantity of emissions (cap-and-trade, cap-and-dividend, or baseline-and-credit), or approaches that directly put carbon prices in place (carbon taxes or subsidies).  Beyond pricing instruments, the other approaches include regulation under the Clean Air Act, energy policies not targeted exclusively at climate change, public nuisance litigation, and NIMBY and other public interventions to block permits for new fossil-fuel related investments.  I will discuss each of these in turn. ...
A Quick Reminder about Cap-and-Trade In brief, there are four principal merits of the cap-and-trade approach to achieving significant reductions of carbon dioxide (CO2) emissions.  First, this approach achieves overall targets at minimum aggregate cost...  Second, the allowance allocation under a cap-and-trade system can be used to build a constituency of political support across sectors and geographic areas without driving up the cost of the program or reducing its environmental performance.  Third, we have significant experience in the United States with the use of this approach, including during the 1980s to phase out leaded gasoline from the marketplace, and since the 1990s to cut acid rain by 50 percent.  Fourth, and of great importance, a domestic cap-and-trade system can be linked directly and cost-effectively with cap-and-trade systems and emission-reduction-credit systems in other parts of the world...
Three principal concerns have been voiced about cap-and-trade systems in U.S. debates.  First, while a cap-and-trade system constrains the quantity of emissions, the costs of control are left uncertain (although such cost uncertainty can be limited — if not eliminated — through the use of safety valves, price collars, or related mechanisms).  Second, in the wake of concerns regarding the role that financial markets played in the global recession, there have been many fears about the possibilities of market manipulation in a cap-and-trade system.  A third concern – in a political context – is that this cost-effective approach to environmental protection, pioneered by the Republican administration of President George H. W. Bush, has – ironically — been demonized by conservatives in current debates. ...
A Populist Approach? Populism has emerged as a major theme in recent electoral politics in the United States, both from the left and from the right.  What might be characterized as a populist approach would be a cap-and-trade system with 100% of the allowances auctioned and the auction revenue returned directly "to the people."  Although this is a standard variant of cap-and-trade design, contemporary politics — with its demonization of the phrase "cap-and-trade" — might well argue for a name change:  how about "cap-and-dividend?"...
The merits of this approach include its simplicity, appearance of fairness, and related appeal to the populist mood.  Concerns, however, include the proposal's relatively modest environmental achievements (according to an analysis by the World Resources Institute), its overall cost due to restrictions on trading, and its apparent political infeasibility, given its lack of visible support in the Congress. ...
Direct Carbon Pricing A carbon tax system would be similar in design to an upstream cap-and-trade approach.  There is some real interest in this approach, mainly from academics, and there is also what I would characterize as "strategic interest," principally from those who recognize that once the focus is on carbon taxes rather than other instruments, political debates will inevitably result in less ambitious targets or, in fact, no policy at all. ...
In this regard, it is important to note that what has frequently been interpreted as hostility to cap-and-trade in the U.S. Senate is actually – on closer inspection — broader hostility to the very notion of carbon pricing (or any climate change policy).  Surely, the political reception to a carbon tax would be even less enthusiastic than the reception that has greeted recent cap-and-trade proposals. ...
Climate Change Regulation under the Clean Air Act Regulations of various kinds may soon be forthcoming – and in some cases, will definitely be forthcoming – as a result of the U.S. Supreme Court decision in Massachusetts v. EPA and the Obama administration's subsequent "endangerment finding" that emissions of carbon dioxide and other greenhouse gases endanger public health and welfare.  This ... identified carbon dioxide as a pollutant under the Clean Air Act...
However, regulatory action on carbon dioxide under the Clean Air Act will accomplish relatively little and do so at relatively high cost, compared with carbon pricing.  ...  Indeed it is reasonable to ask whether this is a credible threat, or will instead turn out to be counter-productive (when stories about the implementation of inflexible, high-cost regulatory approaches lend ammunition to the staunchest opponents of climate policy). ...
Does the Path to National Climate Policy Need to Go through Washington? With political stalemate in Washington, attention may increasingly turn to regional, state, and even local policies intended to address climate change.  The Regional Greenhouse Gas Initiative (RGGI) in the Northeast has created a cap-and-trade system among electricity generators.  More striking, California's Global Warming Solutions Act will likely lead to the creation of a very ambitious set of climate initiatives, including a statewide cap-and-trade system...  The California system is likely to be linked with systems in other states and Canadian provinces under the Western Climate Initiative. ...
An important question is whether there can be sensible sub-national policies even in the presence of an economy-wide Federal carbon-pricing regime?  The answer is surely yes, partly because other market failures will continue to exist that are not addressed by carbon pricing. ...
In the meantime, in the absence of meaningful Federal action, sub-national climate policies could well become the core of national action.  ...
The Path Ahead Conventional politics clearly disfavors market-based (pricing) environmental policy approaches that render costs obvious or at least somewhat transparent, despite the fact that the costs of these same policies are actually less than those of alternative approaches.  Instead, conventional politics favors approaches to environmental protection that render costs less obvious (or better yet invisible), such as renewable portfolio standards, and — for that matter — all sorts of command-and-control performance and technology standards.
But carbon pricing will be necessary to address the diverse economy-wide sources of CO2 emissions effectively and at sensible cost, whether the carbon pricing comes about through an economy-wide Federal cap-and-trade system or through a Federal carbon tax.  It is inconceivable that truly meaningful reductions in CO2 emissions could be achieved through purely regulatory approaches, and it remains true that whatever would be achieved, would be accomplished at excessively high cost.
So, although it is true – as I have sought to explain in this essay – that there are a diverse set of options for future climate policy in the United States, the best available alternative to an economy-wide cap-and-trade system enacted in 2010 may be an economy-wide cap-and-trade system enacted in 2011!

links for 2010-06-23

Posted: 23 Jun 2010 11:05 PM PDT

Do Deficit and Inflation Hawks Know Best?

Posted: 23 Jun 2010 11:43 AM PDT

This is a good example of what's going on with economic policy right now. Marty Feldstein thinks that people ought to be worried about inflation and budget deficits, and the fact that he can't find evidence of this worry puzzles him:

while inflation is very likely to remain low for the next few years, I am puzzled that bond prices show that investors apparently expect inflation to remain low for ten years and beyond, and that they also do not require higher interest rates as compensation for the risk that the fiscal deficit will cause real interest rates to rise in the future.

Instead of questioning his own assumptions in light of evidence that they are incorrect, he suggests implicitly that investors collectively -- i.e. the vaunted market with its ability to incorporate all relevant information into prices -- is wrong. So my question for the deficit and inflation hawks, who are generally those who believe markets to outperform humans in every conceivable way, is this. When do we abandon what markets are actually telling us and instead react to what we -- the less capable humans -- think markets ought to be telling us?

No Changes from the FOMC

Posted: 23 Jun 2010 11:34 AM PDT

As expected, the FOMC tells us how weak the economy is, and that it may be getting weaker. But it expresses confidence that the economy will somehow take care of itself, and decides to stay on hold rather than moving toward a more aggressive monetary policy stance. Here's the Press Release on the decision:

Press Release
Release Date: June 23, 2010
Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.
Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee's flexibility to begin raising rates modestly.

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