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We thank R D’Ecclesi, E. Leeper, I. Parry. and the participants of the 51st Meeting of the Euro Working Group on Commodities and Financial Modeling (EWGCFM) in London and the Midwest Macro Meeting in Urbana for helpful suggestions. The views expressed here are of our own and do not necessarily reflect those of the Central Bank of the Republic of Turkey or the International Monetary Fund. All errors are ours.
See, for example, Golosov, Hassler, Krusell, and Tsyvinski (2014) who calculate the optimal taxes in the global economy to maximize welfare while minimizing carbon emissions in general equilibrium. Sinclair (1990) is an earlier study on optimal fossil fuel taxation. See also de Mooij, Keen, and Parry (2012) for a review of fiscal policy alternatives to mitigate climate change.
There are many papers attempting to calculate the “social cost” of climate change. Papers in this literature include Tol (1995), Nordhaus and Boyer (2000), Maddison (2003), and Rehdanz and Maddison (2005). Tol (2008) surveys a large set of the relevant work. In this paper, we argue that short-term macroeconomic costs can also be large and this implies that they should also be accounted for in pre- and/or post-policy social cost calculations.
We define total oil supply as the sum of US field production and the US net imports of crude oil. The data source is the Energy Information Agency.
For greater realism and a better empirical fit, recent studies on standard medium- and large-scale DSGE models generally include a number of nominal and real frictions in the model. Coupled with an empirically plausible calibration, it has been shown that the impulse responses from such a model can be sufficiently close to those from standard time series estimation methods such as VARs [see Smets and Wouters (2003), among many others]. In particular, many papers, including ours, rely on habit formation to generate persistent, hump-shaped responses of key variables to exogenous shocks.
The existence of convenience yield is a common assumption in commodity storage literature. A non-exhaustive list of relevant papers includes Brennan (1991), Fama and French (1988), and Gibson and Schwartz (1990). More recently, Alquist and Kilian (2010) also adopt this modeling device.
The level of storage is always positive in our framework as the steady state level is positive, sufficiently high, and deviations of storage from its steady state are sufficiently small (within the neighborhood of the steady state). Incorporating non-linearities associated with storage technology is beyond the scope of this paper. Although conceptually appealing, this would make the solution considerably more complicated without providing any additional insight for the issues we focus here.
For the sake of simplicity, we assume that the profits from selling and storing fossil fuel are distributed evenly among the consumers and are included in the lump-sum transfers in the budget constraints of households.
Our selection of 10 percent steady state tax rate for both consumers and producers is reasonable according to data provided by OECD [http://www.oecd-ilibrary.org/deliver/fulltext/9713051ec019.pdf]. We also carry out several sensitivity analyses with higher and different steady state tax rates for consumers and producers. The results do not alter the qualitative nature of the impulse responses, hence our conclusions.
We carried out several sensitivity analyses for elasticity parameters and found that different parameter values do not alter the qualitative nature of the impulse responses, hence our conclusions. The results are available upon request.
This is in line with much of the theoretical literature on optimal simple policies within the New Keynesian class of models. Micro-founded versions of Equation (3.1) that come from a second-order approximation to the utility function of a representative household tend to assign a low value on ϖy, because in a model with nominal rigidities CPI inflation should be assigned a higher weight (see, for example, Schmitt-Grohe and Uribe (2007) and Woodford (2003)).