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Economic Modeling of Climate Change Policy

International Council for Capital Formation
October, 2002
Michael E. Canes


This paper focuses on the economic modeling of European policies to achieve the goals of the Kyoto treaty. The central question addressed is what sorts of models are best suited to analyze the costs of such policies when what is desired are effects on GDP, employment, labor productivity, savings and investment over a period of several years. I also examine the relative merits of bottoms-up and top-down approaches to energy market modeling. The following conclusions are reached:

  • CO2 emissions in most European countries in 2010 will be well above levels needed to meet their commitments.

  • A Kyoto-implementing carbon tax or tradable permit price would have a number of implications for European economies.

  • Different types of economic models capture different impacts.

  • General equilibrium models capture both direct and indirect costs, but assume long run full adjustment of resources and hence fail to capture the costs of those adjustments.

  • Macroeconomic models such as Oxford or DRI-WEFA are general equilibrium models that explicitly account for market disequilibria caused by economic shocks.

  • Bottoms-up energy models are constructed from engineering data applied to specific technologies whereas top-down energy models are based on statistical analysis of past data.

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