Informationally Efficient Climate Policy: Designing Markets to Measure and Price Externalities

I study how policymakers can access and act on the information about climate change damages that is dispersed throughout the economy. I analyze a new dynamic deposit-refund instrument that I label “carbon shares”. This instrument empowers markets to perform price discovery about future damages. I show that there exists a limit-case rational expectations equilibrium in which this instrument: i) efficiently prices new emissions, ii) efficiently incentivizes removal of past emissions, and iii) efficiently aggregates dispersed information about the social cost of emissions. Conventional emission taxes achieve only the first of these objectives, for given information. Calibrated numerical simulations suggest benefits from achieving the other two objectives.