The Market Stability Reserve (MSR), implemented in 2018 to complement the EU emission trading system (EU ETS), is designed such that the supply of allowances responds endogenously to demand. We show that an endogenous cap such as the MSR produces a Green Paradox. Abatement policies announced early but realized in the future are counter-effective because of the MSR: they increase cumulative emissions. We present the mechanisms in a two-period model, and then provide quantitative evidence of our result for an annual 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, such as the European Green Deal. We conclude with suggestions to improve the workings of an endogenous cap, ahead of the MSR review scheduled for 2021.
Conditionally accepted for publication in Economic Policy,
2020
We develop a dynamic regulation game for a stock externality under asymmetric information and future market uncertainty. Within this framework, regulation is characterized as the implementation of a welfare-maximization program conditional on informational constraints. We identify the most general executable such programs and find these yield simple and intuitive policy rules. We apply our theory to carbon dioxide emissions trading schemes and find substantial welfare gains are possible, compared to current practices.
Submitted,
2020
Recent years have seen a rapid increase in the number of cap-and-trade schemes to mitigate greenhouse gas emissions. With many independently operating systems, policy discussions have turned to the topic of linking. This paper offers a theory of optimal linking. We show that an efficient linkage adjusts the joint cap in response to inter-scheme trades of allowances. Compared to standard linking, our proposal has two major advantages. First, it increases global welfare by efficiently adjusting the cap in response to private information implicitly contained in inter-scheme trades. Second, post-linking price volatility is lower with an endogenous cap. The latter advantage may alleviate existing political barriers to linking such as imported price volatility. A key concept in our analysis is asymmetric uncertainty. Interestingly, while asymmetric information generally decreases welfare, asymmetric uncertainty compensates for part (or, in extreme cases, all) of that welfare loss.
2020
We study disease control in a game of imperfect information. While disease control games of perfect information tend to have multiple equilibria, we show that even a small amount of uncertainty leads to equilibrium uniqueness. In equilibrium, an epidemic may occur even though it is inefficient and could have been avoided. Moreover, less harmful diseases may cause more deaths. We extend the game to study cooperation and let a subset of players commit to control the disease whenever the expected benefit of doing so is sufficiently high. The equilibrium is again unique. Selection of a more favorable equilibrium is facilitated by this type of cooperation.
2020
Global games are incomplete information games where players receive private noisy signals about the true game played. In a sequential global game, the set of players is partitioned into subsets. Players within a subset (of the partition) play simultaneously but no two subsets move at the same time. The resulting sequence of stages introduces intricate dynamics not encountered in static global games. We show that a sequential global game with strategic complementarities and binary actions has at least one equilibrium in monotone strategies. When signals are sufficiently precise, the sequential global game has a unique equilibrium satisfying iterated dominance, forward induction, and backward induction, even if the complete information game (given the partition of the player set) has multiple equilibria. Several applications are discussed.
R.J.R.K. Heijmans
2020
