Optimal Emission Prices Over the Business Cycles

Abstract

We prove that under the most typical circumstances optimal emission prices are procyclical, i.e., prices should be lower during recessions. The procyclicality is more likely when emissions propagate very slowly into environmental damage. A prime example of such process is CO2 emissions. We show that carbon prices should be closely linked to the fuctuations of the marginal utility of consumption, which implies relatively modest magnitude of carbon price fuctuations. Our fndings imply that climate policies should focus on setting the carbon price to the optimal growth path level and give carbon price fuctuations only a secondary role. Opposite to the carbon price, the cyclicality of optimal emissions depends on the production technology in the energy sector, and may become countercyclical in future if the technology mix becomes less fossil dependent.