Environmental Macroeconomics

Optimal Trading Ratios under Permit Trading Frictions

Abstract

This paper identifies a new rationale for optimal trading ratios to deviate from marginal damage ratios: trading frictions, pervasive in permit markets yet absent from the literature. Work on ratios assumes frictionless trading, where allocations are irrelevant. Work on transaction costs never treats ratios as a policy instrument. Treating both as instruments, optimal ratios depart from marginal damage ratios even absent asymmetric information and even for uniformly mixed pollutants like carbon. Under asymmetric information the regulator faces three objectives and two instruments, so the first best is unattainable. A calibration to EU ETS Phase 3 quantifies the gains.

Multiple Equilibria in Differentiated Permit Markets (R&R)

Abstract

Recent advances in damage estimation and optimal trading ratio theory have made differentiated permit markets a viable policy option. This paper identifies a latent risk from implementing such policies that the literature has overlooked. A differentiated permit market can admit multiple equilibria, and the market and regulator may settle on a welfare-inferior one. I show that the very act of optimally adjusting trading ratios in response to permit prices—while facing policy adjustment costs—can generate multiple equilibria through positive feedback between prices and ratios. I characterize conditions under which multiplicity arises and quantify the associated welfare losses. Finally, I propose a novel hump-shaped permit supply rule that eliminates multiplicity by aligning supply with the curvature of effective demand.

Carbon Revenue Financed Green Subsidies and Multiple Equilibria

Abstract

This paper uncovers a novel adverse effect of financing green subsidies with carbon pricing revenue. We study an overlapping generations economy with green and brown capital, constructed so that neither the planner's allocation nor the decentralized equilibrium under separately financed instruments admits multiplicity. Within that benchmark, financing green subsidies through carbon tax revenues under a balanced budget rule induces strategic complementarity in portfolio decisions, generating coordination problems. The budget rule alone drives the multiplicity, making the coordination failure policy-induced rather than fundamentals-driven. Simple redesigns of the balanced budget rule that restore uniqueness are studied and proposed.

Permit Trading Frictions, Co-Pollutants, and the Case for Cap-and-Trade  with MinJung Kwak

Abstract

We develop an over-the-counter emissions trading model featuring intermediaries, search and bargaining frictions, firm-specific abatement costs, and localized co-pollutant damages. Permit prices, volume, and emissions distribution arise endogenously. We examine how market microstructure, abatement cost heterogeneity, and damage functions shape equilibrium outcomes. Contrary to Weitzman (1974), we show that cap-and-trade can outperform a carbon tax because trading frictions compress emissions dispersion across firms, thereby reducing total damages from local co-pollutants. Calibrated to EU ETS data, optimizing dealer availability reduces deadweight loss to 83% of that under a uniform EU-wide carbon tax, given benchmark discount rate and local damage coefficient.

Long-Run Economic Impacts of Climate Variability  with Sungwon Lee

Abstract

We estimate long-run economic impacts of climate volatility by employing a stochastic frontier model where climate volatility is additionally included into the production frontier. Our climate panel dataset covers 157 countries over the period 1950-2014. We find that both temperature and precipitation affect production possibilities in a hump-shaped way. Most importantly, temperature volatility turns out to reduce long-term potential output. This negative effect is found to be statistically significant, and various robustness checks, including income as well as temperature  heterogeneity across nations, confirm it. We also find short-term weather anomalies, either temperature or precipitation, are found to be insignificant across all specifications. Our findings provide supporting empirical evidence for a growing body of Integrated Assessment Model literature, emphasizing the role of uncertainty about global temperature dynamics. 

Monetary Economics

Central Bank Interventions and Liquidity in the Treasury Market (and beyond)  with Athanasios Geromichalos, Ioannis Kospentaris, Changhyun Lee, Sukjoon Lee

Abstract

Central banks around the world routinely engage in asset purchases in secondary markets as part of implementing monetary policy or enhancing market liquidity, but the effects of such interventions are not yet fully understood. We develop a multi-asset general equilibrium model in which the liquidity of an asset is endogenous and depends on the terms of trade in each asset's respective secondary market, which are, in turn, driven by agents’ market entry decisions and the possibility of central bank intervention. We use our model to qualitatively and quantitatively rationalize the superior liquidity of U.S. Treasuries over corporate bonds of comparable safety. Our model highlights and quantifies an unexplored link between fiscal and monetary policy: central bank interventions in the market for Treasuries increase secondary market liquidity for these securities, thus indirectly aiding the Treasury to borrow at lower rates. Our results also reveal that central bank interventions can have spillover effects on markets where the bank does not participate, offering a cautionary note to both policymakers and empirical researchers.