TAX WHAT YOU DON'T WANT:

So, how should one approach the problem instead? Traditional economic models largely ignore how climate risk interacts with the state of the economy. But what if investments in emissions reductions followed the same logic used by professional asset managers? There is a good reason why investors put money into bonds despite their average returns falling well below those of stocks: bonds are less risky. Thus, even when the economy is faring poorly, some investments will still pay off.

In Climate Shocks, one of our main characters is Robert Litterman, a former top risk manager for Goldman Sachs who was shocked to find out how standard benefit-cost analyses of climate change were treating risk and uncertainty. Together with Kent Daniel of the Columbia Business School, Litterman and I set out to build a simple climate-economic model that takes seriously the basic insights from the financial industry.

Unlike the Stern Review, which simply selected a discount rate ex cathedra, we made the discount rate an outcome rather than an input in our approach. Treating atmospheric carbon as an "asset" (albeit one with negative payoffs), we calibrated a carbon price, following the methods used by the finance industry to price assets. In the end, no matter how hard we tried, we could not get the price of carbon below $100 per ton.

Meanwhile, other analyses have come up with carbon prices ranging from $200 to $400 or more per ton. But even if one stipulates that the price should be $100 per ton, that would translate into around $0.90 per gallon (3.8 liters) of gasoline - a charge at the pump that would feel more like a revolution than like a modest policy measure.

Tweet   @brothersjudd