Monetary Emissions Trading Mechanisms

Monnet, Cyril; Temzelides, Ted (2016). Monetary Emissions Trading Mechanisms. International Journal of Economic Theory, 12(1), pp. 85-100. Wiley-Blackwell 10.1111/ijet.12075

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Trade in permits has been proposed, and in some cases implemented, as a tool to reduce pollution. We use a dynamic framework from monetary theory to model permits. We derive properties of optimal permits tr ading mechanisms under private information concerning the firms’ tendency to pollute. When the firms’ capital vintage is fixed, both emissions taxes and trade in permits can support the first-best. Both policies, however, can fail to achieve efficiency if firms endogenously choose their composition of capital stock across clean and dirty vintages. If permit requirements and taxes depend on the firms’ vintage composition, in addition to ex post emissions, both policies can support efficiency. In both setups, the banking of notes is not necessary and may even break this equivalence in favor of taxes.

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