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Review of Environmental Economics and Policy Advance Access originally published online on January 6, 2009
Review of Environmental Economics and Policy 2009 3(1):84-103; doi:10.1093/reep/ren016
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© The Author 2009. Published by Oxford University Press on behalf of the Association of Environmental and Resource Economists. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Balancing Cost and Emissions Certainty: An Allowance Reserve for Cap-and-Trade

Brian C. Murray*, Richard G. Newell{dagger} and William A. Pizer{ddagger}

* Director for Economic Analysis, Nicholas Institute, and Research Professor, Nicholas School of the Environment, Duke University.
{dagger} Gendell Associate Professor of Energy and Environmental Economics, Nicholas School of the Environment, Duke University, a University Fellow at Resources for the Future, and a Research Associate at the National Bureau of Economic Research. E-mail: richard.newell{at}duke.edu.
{ddagger} Senior Fellow at Resources for the Future. Senior authorship is not assigned.

On efficiency grounds, the economics community has to date tended to emphasize price-based policies to address climate change—such as taxes or a "safety-valve" price ceiling for cap-and-trade—while environmental advocates have sought a more clear quantitative limit on emissions. This article presents a simple modification to the idea of a safety valve: a quantitative limit that we call the allowance reserve. Importantly, this idea may bridge the gap between competing interests and potentially improve efficiency relative to tax or other price-based policies. The last point highlights the deficiencies in several previous studies of price and quantity controls for climate change that do not adequately capture the dynamic opportunities within a cap-and-trade system for allowance banking, borrowing, and intertemporal arbitrage in response to unfolding information.

JEL Classification: Q54, Q58, L51, D8

The research was supported in part by a grant from the Swedish Foundation for Strategic Environmental Research (MISTRA). The authors acknowledge Joseph Aldy, Jon Anda, Jason Grumet, Suzanne Leonard, Tim Profeta, Nicole St. Clair, Robert Stavins, Tracy Terry, an anonymous referee, and participants at the Resources for the Future workshop, "Managing Costs in a U.S. GHG Trading Program," (Pizer and Tatsutani 2008) for their insights and suggestions on this issue.


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