Addressing policy credibility problems for low-carbon investment

A combination of characteristics of the climate change problem make the credibility of future commitments crucial for climate policy: the long lifetimes of carbon dioxide in the atmosphere and of energy infrastructure requires a long term perspective; the inherently global aspects of the atmosphere as a public good requires international coordination; decarbonizing the global economy depends on the incentives for investment in innovation; and persistent uncertainty both about the problem and potential solutions necessitate adapting to new information. Even in a first best world, climate policy design needs to navigate a tradeoff between making commitments that are sufficiently credible to stimulate transformation and retaining flexibility to adjust. The goal of this paper is to use the experience in other policy areas to assemble a broad set of possible remedies for addressing credibility problems and then characterize the advantages and disadvantages of each. We first review the theory and practice of addressing credibility problems in monetary, fiscal, and trade policy. From this we derive a taxonomy of four policy design categories. As a preliminary example, we then apply this framework to assess the credibility of climate targets made by selected developing countries as part of the United Nations Framework Convention on Climate Change process. Finally, we evaluate the items in the taxonomy as policy alternatives in terms of their effects on incentives for investment in low-carbon technology. (C) 2016 Elsevier Ltd. All rights reserved.