Believe me when I say green! Heterogeneous expectations and climate policy uncertainty

Campiglio, Emanuele, Lamperti, Francesco and Terranova, Roberta (2024) Believe me when I say green! Heterogeneous expectations and climate policy uncertainty. Journal of Economic Dynamics and Control, 165. ISSN 0165-1889

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Abstract

We develop a dynamic model where heterogeneous firms take investment decisions depending on their beliefs on future carbon prices. A policy-maker announces a forward-looking carbon price schedule but can decide to default on its plans if perceived transition risks are high. We show that weak policy commitment, especially when combined with ambitious mitigation announcements, can trap the economy into a vicious circle of credibility loss, carbon-intensive investments and increasing risk perceptions, ultimately leading to a failure of the transition. The presence of behavioural frictions and heterogeneity - both in capital investment choices and in the assessment of the policy-maker's credibility - has strong non-linear effects on the transition dynamics and the emergence of ‘high-carbon traps’. We identify analytical conditions leading to a successful transition and provide a numerical application for the EU economy.

Item Type:	Article
Additional Information:	© 2024 The Author(s)
Divisions:	Grantham Research Institute
Subjects:	H Social Sciences > HB Economic Theory G Geography. Anthropology. Recreation > GE Environmental Sciences
JEL classification:	D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D84 - Expectations; Speculations C - Mathematical and Quantitative Methods > C6 - Mathematical Methods and Programming > C63 - Computational Techniques Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q5 - Environmental Economics > Q54 - Climate; Natural Disasters Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q5 - Environmental Economics > Q58 - Government Policy
Date Deposited:	12 Jul 2024 13:45
Last Modified:	14 Sep 2024 10:11
URI:	http://eprints.lse.ac.uk/id/eprint/124234

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