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Credibility in carbon policy

Carbon policy faces an intractable trade-off: while credible commitment to future policy improves the dynamic efficiency of incentives it imposes costs in form of reduced flexibility to respond to changing circumstances. Investors favor long-term stability of the regulatory regime. But considerable uncertainty prevails, resulting in increased market risks and investment hold-up. Uncertainty stems from strategic interactions between government and firms, potential learning about climate damage and abatement cost, and volatile political preferences. This paper surveys commitment devices which help government to rise the level of commitment while also leaving some room for flexible adjustments. In particular, the proposals of legislating a long-term carbon budgeting framework, delegation to an independent carbon central bank, and securitization of investors’ stakes in emission markets seem palliative approaches and are worthy of deeper investigation.