Discussion Paper

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

Jul 15, 2008 | Brian C. Murray, Richard G. Newell, William A. Pizer


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 paper presents a simple modification to the idea of a safety valve: a quantitative limit that we call the allowancereserve. 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.