Emissions targets and the real business cycle: Intensity targets versus caps or taxes

For reducing greenhouse gas emissions, intensity targets are attracting interest as a flexible mechanism that would better allow for economic growth than emissions caps. For the same expected emissions, however, the economic responses to unexpected productivity shocks differ. Using a real business cycle model, we find that a cap dampens the effects of productivity shocks in the economy on all variables except for the shadow value of the emissions constraint. An emissions tax leads to the same expected outcomes as a cap but with greater volatility. Certainty-equivalent intensity targets maintain higher levels of labor, capital, and output than other policies, with lower expected costs and no more volatility than with no policy.

► We use a real business cycle model to assess policies for reducing greenhouse gas emissions.
► We assess the implications of productivity uncertainty on economic outcomes.
► An emissions cap dampens the effects of productivity shocks in the economy.
► An emissions tax leads to the same expected outcomes as a cap but with greater volatility.
► An intensity target maintains higher levels of labor, capital, and output than other policies.