Scandinavian Working Papers in Economics
Working Paper Series,
Norwegian University of Life Sciences, School of Economics and Business
No 4-2020: Endogenous Emission Caps Always Produce a Green Paradox
Reyer Gerlagh (), Roweno J. R. K. Hejimans () and Knut Einar Rosendahl ()
Additional contact information
Reyer Gerlagh: Department of Economics, Tilburg University, Postal: Tilburg University, Department of Economics, P.O.box 90153, 5037 AB Tilburg, The Netherlands, Norway
Roweno J. R. K. Hejimans: Department of Economics, Tilburg University, Postal: Tilburg University, Department of Economics, P.O.box 90153, 5037 AB Tilburg, The Netherlands, Norway
Knut Einar Rosendahl: School of Economics and Business, Norwegian University of Life Sciences, Postal: Norwegian University of Life Sciences, School of Economics and Business, P.O. Box 5003 NMBU, N-1432 Ås, Norway
Abstract: For any emission trading system (ETS) with quantity-based endogenous supply of allowances, there exists an allowances-demand reducing policy that increases aggregate supply and thus cumulative emissions. We establish this green paradox in a general model and apply the insights to the Market Stability Reserve (MSR) in the EU ETS, implemented in 2018. We show that demand-reducing policies announced in early periods but realized in the future, such as decisions to phase out coal power, can be inverted by the new rules: they may increase cumulative emissions. We provide quantitative evidence of our result for a model disciplined on the price rise in the EU ETS that followed the introduction of the MSR. Our results point to the need for better coordination between different policies in the "European Green Deal" proposed by the European Commission late 2019.
Keywords: Emissions trading; Green paradox; EU ETS; environmental policy; dynamic modeling
JEL-codes: D59; E61; H23; Q50; Q54; Q58
39 pages, May 8, 2020
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