M-RCBG Faculty Working Paper No. 2011-09

Using the Market to Address Climate Change: Insights from Theory and Experience

Joseph E. Aldy and Robert N. Stavins

September 2011

Abstract

Emissions of greenhouse gases linked with global climate change are affected by diverse aspects of economic activity, including individual consumption, business investment, and government spending. An effective climate policy will have to modify the decision calculus for these activities in the direction of more efficient generation and use of energy, lower carbonintensity of energy, and – more broadly – a more carbon‐lean economy. The only approach to doing this on a meaningful scale that would be technically feasible and cost‐effective is carbon pricing, that is, market‐based climate policies that place a shadow‐price on carbon dioxide emissions. We examine alternative designs of three such instruments – carbon taxes, cap‐andtrade, and clean energy standards. We note that the U.S. political response to possible marketbased approaches to climate policy has been and will continue to be largely a function of issues and structural factors that transcend the scope of environmental and climate policy.

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