The price vs quantity debate: climate policy and the role of business cycles
What is the optimal instrument design and choice for a regulator attempting to control emissions by private agents in face of uncertainty arising from business cycles? In applying Weitzman's result [Prices vs. quantities, Review of Economic Studies, 41 (1974), 477-491] to the problem of greenhouse gas emissions, the price-quantity literature has shown that, under uncertainty about abatement costs, price instruments (carbon taxes) are preferred to quantity restrictions (caps on emission), since the damages from climate change are relatively at. On the other hand, another recent piece of academic literature has highlighted the importance of adjusting carbon taxes to business cycle fluctuations in a procyclical manner. In this paper, analyze the optimal design and the relative performance of price versus quantity instruments in the face of uncertainty stemming from business cycles.