The Impact of Socio-Economic Inertia and Restrictions on Net-Negative Emissions on Cost-Effective Carbon Price Pathways

Abstract

Many countries have indicated to plan or consider the use of carbon pricing. Model-based scenarios are used to inform policymakers about emissions pathways and cost-effective carbon prices. Many of these scenarios are based on the Hotelling rule, assuming that a carbon price path increasing with the interest rate leads to a cost-effective strategy. We test the robustness of this rule by using experiments with plausible assumptions for learning by doing, inertia in reducing emissions, and restrictions on net-negative emissions. Analytically, we show that if mitigation technologies become cheaper if their capacities are increased, Hotelling does not always apply anymore. Moreover, the initial carbon price is heavily influenced by restrictions on net-negative emissions and the pathway by both restrictions on net-negative emissions and socio-economic inertia. This means that Hotelling pathways are not necessarily optimal: in fact, combining learning by doing and the above restrictions leads to initial carbon prices that are more than twice as high as a Hotelling pathway and thus to much earlier emission reductions. The optimal price path also increases less strongly and may even decline later in the century, leading to higher initial abatement costs but much lower long-term costs.