Join SCU faculty for Professor Stephen Salant of the University of Michigan for a presentation of his recent research.
Cap-and-trade programs rather than emissions taxes are being utilized as the main vehicle to combat global warming by national (and state) governments of advanced countries. Although sometimes exceedingly complex, cap-and-trade regulations share some common features that have escaped notice. Previous analyses have assumed that firms must be in continual compliance, surrendering permits as they pollute. As we showed in a companion paper (Hasegawa and Salant, 2010), if firms must cover their emissions on a continuing basis, then in the absence of uncertainty, the price path of permits may remain constant over measurable intervals while the government sells additional permits at a ceiling price or may even collapse in response to an anticipated injection of permits through a government auction.
Despite the implicit assumption of this literature, however, no cap-and-trade program actually requires continual compliance. The three federal bills and California's AB-32, for example, all permit firms to be out of compliance for substantial intervals (one year in some cases and as long as three years in other cases). Such ``delayed compliance'' programs require that firms surrender permits periodically to cover their cumulative emissions since the last compliance period. Anticipated injections of additional permits during the compliance period should not affect the rate of change of price although they will affect the position of the equilibrium price path. We develop a general methodology for analyzing the effects of such injections of additional permits. Using it, we explain why the sales provisions of one federal bill ( Kerry-Lieberman) might generate a speculative attack in the permit market and why one provision of the California program may undermine the very existence of an equilibrium.