Publication Date

2013-04-22

Availability

Open access

Embargo Period

2013-04-22

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PHD)

Department

Economics (Business)

Date of Defense

2013-04-11

First Committee Member

David L. Kelly

Second Committee Member

Michael Connolly

Third Committee Member

Christopher F. Parmeter

Fourth Committee Member

Manuel Santos

Fifth Committee Member

Tie Su

Abstract

This body of work consists of four essays studying topics in environmental economics and international economics. The main interests in this thesis are to evaluate the effects of different government policies. Particularly, we explore the effects the optimal abatement policy for the world economy and the foreign exchange policy in China. My first essay studies the effect of potentially severe climate change on optimal climate change policy, accounting for learning and uncertainty in the climate system. In particular, we test how fat upper tailed uncertainty over the temperature change from a doubling of greenhouse gases (the climate sensitivity), affects economic growth and emissions policy. In addition, we examine whether and how fast uncertainties could be diminished through Bayesian learning. Our results indicate that while overall learning is slow, the mass of the fat tail diminishes quickly, since observations near the mean provide evidence against fat tails. We denote as “partial learning” the case where the planner rejects high values of the climate sensitivity with high confidence, even though significant uncertainty remains. Fat tailed uncertainty without learning reduces current emissions by 38% relative to certainty, indicating significant climate insurance, or paying to limit emissions today to reduce the risk of very high temperature changes, is optimal. However, learning reduces climate insurance by about 50%. The optimal abatement policy is strongly influenced by the current state of knowledge, even though greenhouse gas (GHG) emissions are difficult to reverse. Non-fat tailed uncertainty is largely irrelevant for optimal emissions policy. My second essay provides a new solution algorithm for discrete time stochastic models of climate and the economy, relying on a nonparametric approximation of the value function. It is known by the dynamic programming theory that the value function is globally increasing and concave, but such information is not exploited by conventional approximation methods. This presents a challenge for solving the integrated assessment models numerically because climate change models have a large state space. The curse of dimensionality limits the size of the grid used in typical solution methods. Without concavity, local maxima can form in areas of the state space where grid points are sparse, which slows convergence. Therefore we establish a general approach to impose shape preserving constraints based on nonparametric econometrics by solving a quadratic programming problem. Then we illustrate stability and accuracy of the algorithm using an optimal growth model and a simple integrated assessment model with analytical solutions. My third essay evaluates China’s neutralization policy by monthly estimations based on the central bank balance sheet from 1999:6 to 2011:6. Our results suggest that China effectively neutralizes 66% of the change of net foreign assets under a pegged currency regime. Consequently, a purchase of one yuan of net foreign assets leads to an effective increase of 1.4 yuan in the money supply, rather than 4 yuan in the absence of neutralization. In the face of rapid growth of foreign reserves, neutralization in China is becoming increasingly difficult, consistent with Mundell’s hypothesis that monetary authorities can fix the exchange rate and let the money supply float, or fix the money supply and let the exchange rate float: but it cannot fix both the exchange rate and the money supply. My fourth essay estimates China’s demand for foreign reserves from 1994:1 to 2007:4. Using a monetary model for China’s reserve demand, we take into account the People’s Bank of China’s systematic neutralization policy to reduce inflation. While ultimately inconsistent, this policy has led to a growth in foreign exchange reserves that seems limitless: a neutralization coefficient of 0.57 leading to a magnification effect on the increase in reserves of 2.3. That is, a purchase of foreign reserves leads to a contraction of domestic credit of 57% of the foreign exchange purchase, which in turn magnifies the surplus under a stable exchange rate.

Keywords

climate change; uncertainty; fat tail; integrated assessment model; foreign exchange reserves; China

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