Time-consistent carbon pricing: The role of carbon contracts for differences

Abstract

Carbon pricing decisions by governments are prone to time-inconsistency, which causes the private sector to underinvest in emission-reducing technologies. We show that incentives for decarbonization can be improved if complementing carbon pricing with carbon contracts for differences, where the government commits to pay a fixed carbon price level to the investors. We derive conditions under which the government is willing to "tie its hands" with the contracts. ; A previous version of this paper was titled: "Time-consistent carbon pricing".