Author: John Sloman

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Should central bank targets be changed?

Central bankers, policymakers, academics and economists met at the Economic Symposium at Jackson Hole, Wyoming from August 24–26. This annual conference, hosted by Kansas City Fed, gives them a chance to discuss current economic issues and the best policy responses. The theme this year was ‘Structural Shifts in the Global Economy’ and one of the issues discussed was whether, in the light of such shifts, central banks’ 2 per cent inflation targets are still appropriate.

Inflation has been slowing in most countries, but is still above the 2 peer cent target. In the USA, CPI inflation came down from a peak of 9.1% in June 2022 to 3.2% in July 2023. Core inflation, however, which excludes food and energy was 4.7%. At the symposium, in his keynote address the Fed Chair, Jay Powell, warned that despite 11 rises in interest rates since April 2022 (from 0%–0.25% to 5%–5.25%) having helped to bring inflation down, inflation was still too high and that further rises in interest rates could not be ruled out.

We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.

However, he did recognise the need to move cautiously in terms of any further rises in interest rates as “Doing too much could also do unnecessary harm to the economy.” But, despite the rises in interest rates, growth has remained strong in the USA. The annual growth rate in real GDP was 2.4% in the second quarter of 2023. Unemployment, at 3.5%, is low by historical standards and similar to the rate before the Fed began raising interest rates.

Raising the target rate of inflation?

Some economists and politicians have advocated raising the target rate of inflation from 2 per cent to, perhaps, 3 per cent. Jason Furman, an economic policy professor at Harvard and formerly chief economic advisor to President Barack Obama, argues that a higher target has the benefit of helping cushion the economy against severe recessions, especially important when such there have been adverse supply shocks, such as the supply-chain issues following the COVID lockdowns and then the war in Ukraine. A higher inflation rate may encourage more borrowing for investment as the real capital sum will be eroded more quickly. Some countries do indeed have higher inflation targets, as the table shows.

Powell emphatically ruled out any adjustment to the target rate. His views were expanded upon by Christine Lagarde, the head of the European Central Bank. She argued that in a world of greater supply shocks (such as from climate change), greater frictions in markets and greater inelasticity in supply, and hence greater price fluctuations, it is important for wage increases not to chase price increases. Increasing the target rate of inflation would anchor inflationary expectations at a higher level and hence would be self-defeating. Inflation in the eurozone, as in the USA, is falling – it halved from a peak of 10.6% in 2022 to 5.3% in July this year. Given this and worries about recession, the ECB may not raise interest rates at its September meeting. However, Lagarde argued that interest rates needed to remain high enough to bring inflation back to target.

The UK position

The Bank of England, too, is committed to a 2 per cent inflation target, even though the inflationary problems for the UK economy are greater that for many other countries. Greater shortfalls in wage growth have been more concentrated amongst lower-paid workers and especially in the public health, safety and transport sectors. Making up these shortfalls will slow the rate of inflationary decline; resisting doing so could lead to protracted industrial action with adverse effects on aggregate supply.

Then there is Brexit, which has added costs and bureaucratic procedures to many businesses. As Adam Posen (former member of the MPC) points out in the article linked below:

Even if this government continues to move towards more pragmatic relations with the EU, divergences in standards and regulation will increase costs and decrease availability of various imports, as will the end of various temporary exemptions. The base run rate of inflation will remain higher for some time as a result.

Then there is a persistent problem of low investment and productivity growth in the UK. This restriction on the supply side will make it difficult to bring inflation down, especially if workers attempt to achieve pay increases that match cost-of-living increases.

Sticking to the status quo

There seems little appetite among central bankers to adjust inflation targets. Squeezing inflation out of their respective economies is painful when inflation originates largely on the supply side and hence the problem is how to reduce demand and real incomes below what they would otherwise have been.

Raising inflation targets, they argue, would not address this fundamental problem and would probably simply anchor inflationary expectations at the higher level, leaving real incomes unchanged. Only if such policies led to a rise in investment would a higher target be justified and central bankers do not believe that it would.

Articles

Data

Questions

  1. Use an aggregate demand and supply diagram (AD/AS or DAD/DAS) to illustrate inflation since the opening up of economies after the COVID lockdowns. Use another one to illustrate the the effects of central banks raising interest rates?
  2. Why is the world likely to continue experiencing bigger supply shocks and greater price volatility than before the pandemic?
  3. With hindsight, was increasing narrow money after the financial crisis and then during the pandemic excessive? Would it have been better to have used the extra money to fund government spending on infrastructure rather than purchasing assets such as bonds in the secondary market?
  4. What are the arguments for and against increasing the target rate of inflation?
  5. How do inflationary expectations influence the actual rate of inflation?
  6. Consider the arguments for and against the government matching pay increases for public-sector workers to the cost of living.
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The growing gap between rich and poor

A recent report published by the High Pay Centre shows that the median annual CEO pay of the FTSE 100 companies rose by 15.7% in 2022, from £3.38 million in 2021 to £3.91 million – double the UK CPIH inflation rate of 7.9%. Average total pay across the whole economy grew by just 6.0%, representing a real pay cut of nearly 2%.

The pay of top US CEOs is higher still. The median annual pay of S&P 500 CEOs in 2022 was a massive $14.8 million (£11.7 million). However, UK top CEOs earn a little more than those in France and Germany. The median pay of France’s CAC40 CEOs was €4.9 million (£4.2 million). This compares with a median of £4.6 million for the CEOs of the top 40 UK companies. The mean pay of Germany’s DAX30 CEOs was €6.1 million (£5.2 million) – lower than a mean of £6.0 million for the CEOs of the top 30 UK companies.

The gap between top CEO pay and that of average full-time workers narrowed somewhat after 2019 as the pandemic hit company performance. However, it has now started widening again. The ratio of the median UK CEO pay to the median pay of a UK full-time worker stood at 123.1 in 2018. This fell to 79.1 in 2020, but then grew to 108.1 in 2021 and 118.1 in 2022.

The TUC has argued that workers should be given seats on company boards and remuneration committees that decide executive pay. Otherwise, the gap is likely to continue rising, especially as remuneration committees in specific companies seek to benchmark pay against other large companies, both at home and abroad. This creates a competitive upward push on remuneration. What is more, members of remuneration committees have the incentive to be generous as they themselves might benefit from the process in the future.

Although the incomes of top CEOs is huge and growing, even if they are excluded, there is still a large gap in incomes between high and low earners generally in the UK. In March 2023, the top 1 per cent of earners had an average gross annual income of just over £200 000; the bottom 10 per cent had an average gross annual income of a little over £8500 – just 4.24% of the top 1 per cent (down from 4.36% in March 2020).

What is more, in recent months, the share of profits in GDP has been rising. In 2022 Q3, gross profits accounted for 21.2% of GDP. By 2023 Q2, this had risen to 23.4%. As costs have risen, so firms have tended to pass a greater percentage increase on to consumers, blaming these price increases on the rise in their costs.

Life at the bottom

The poor spend a larger proportion of their income on food, electricity and gas than people on average income; these essential items have a low income elasticity of demand. But food and energy inflation has been above that of CPIH inflation.

In 2022, the price of bread rose by 20.5%, eggs by 28.9%, pasta by 29.1%, butter by 29.4%, cheese by 32.6% and milk by 38.5%; the overall rise in food and non-alcoholic beverages was 16.9% – the highest rise in any of the different components of consumer price inflation. In the past two years there has been a large increase in the number of people relying on food banks. In the six months to September 2022, there was a 40% increase in new food bank users when compared to 2021.

As far as energy prices are concerned, from April 2022 to April 2023, under Ofgem’s price cap, which is based on wholesale energy prices, gas and electricity prices would have risen by 157%, from £1277 to £3286 for the typical household. The government, however, through the Energy Price Guarantee restricted the rise to an average of £2500 (a 96% rise). Also, further help was given in the form of £400 per household, paid in six monthly instalments from October 2022 to March 2023, effectively reducing the rise to £2100 (64%). Nevertheless, for the poorest of households, such a rise meant a huge percentage increase in their outgoings. Many were forced to ‘eat less and heat less’.

Many people have got into rent arrears and have been evicted or are at risk of being so. As the ITV News article and videos linked below state: 242 000 households are experiencing homelessness including rough sleeping, sofa-surfing and B&B stays; 85% of English councils have reported an increase in the number of homeless families needing support; 97% of councils are struggling to find rental properties for homeless families.

Financial strains have serious effects on people’s wellbeing and can adversely affect their physical and mental health. In a policy research paper, ‘From Drained and Desperate to Affluent and Apathetic’ (see link below), the consumer organisation, Which?, looked at the impact of the cost-of-living crisis on different groups. It found that in January 2023, the crisis had made just over half of UK adults feel more anxious or stressed. It divided the population into six groups (with numbers of UK adults in each category in brackets): Drained and Desperate (9.2m), Anxious and At Risk (7.9m), Cut off by Cutbacks (8.8m), Fretting about the Future (7.7m), Looking out for Loved Ones (8.9m), Affluent and Apathetic (8.8m).

The majority of the poorest households are in the first group. As the report describes this group: ‘Severely impacted by the crisis, this segment has faced significant physical and mental challenges. Having already made severe cutbacks, there are few options left for them.’ In this group, 75% do not turn the heating on when cold, 63% skip one or more meals and 94% state that ‘It feels like I’m existing instead of living’.

Many of those on slightly higher incomes fall into the second group (Anxious and At Risk). ‘Driven by a large family and mortgage pressure, this segment has not been particularly financially stable and experienced mental health impacts. They have relied more on borrowing to ease financial pressure.’

Although inflation is now coming down, prices are still rising, interest rates have probably not yet peaked and real incomes for many have fallen significantly. Life at the bottom has got a lot harder.

Articles

Reports

Data

Questions

  1. What are the arguments for and against giving huge pay awards to CEOs?
  2. What are the arguments for and against raising the top rate of income tax to provide extra revenue to distribute to the poor? Distinguish between income and substitution effects.
  3. What policies could be adopted to alleviate poverty? Why are such policies not adopted?
  4. Using the ONS publication, the Effects of taxes and benefits on UK household income, find out how the distribution of income between the various decile groups of household income has changed over time? Comment on your findings.
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Global boiling – why not take urgent action now?

The global average temperature for July 2023 was the highest ever recorded and July 3rd was the world’s hottest day on record. We’ve seen scenes of wildfires raging across much of southern Europe, people suffering searing temperatures in south-west USA, southern India and western China, flash floods in South Korea, Japan and eastern USA. These are all directly related to global warming, which is causing weather systems to become more extreme. And as the planet continues to warm, so these problems will intensify.

The Secretary General of the United Nations, Antonio Guterres, in a press conference on 27 July warned that:

Climate change is here. It is terrifying. And it is just the beginning. The era of global warming has ended; the era of global boiling has arrived. The air is unbreathable. The heat is unbearable. And the level of fossil-fuel profits and climate inaction is unacceptable. Leaders must lead. No more hesitancy. No more excuses. No more waiting for others to move first. There is simply no more time for that.

The environmental, human, social and economic impact of global warming is huge, but concentrated on just part of the world’s population. For many, a more variable climate is at worst an inconvenience – at least in the short term. But it is the short term that politicians are most concerned about when seeking to win the next election.

Tackling climate change requires action to reduce carbon emissions now, even though the effects take many years. But one person’s emissions make only a minuscule contribution to global warming. So why not be selfish and carry on driving, flying off on holiday, using a gas boiler and eating large amounts of red meat? This is what many people want to do and governments know it. Many people do not like green policies as they involve sacrifice. Examples include higher fuel prices and restrictions on what you can do. So, despite the visions of fires, floods and destruction, governments are wary about raising fuel taxes, airport duties and charges to use old high-emission cars in cities; wary about raising taxes generally to provide subsidies for sustainable power generation; wary about banning new oil and gas fields that would reduce reliance on imported fuel.

Because the external costs of carbon emissions are so high and global, government action is required to change behaviour. Education can help and scenes of devastation from around the world may change the hearts and minds or some people. Also, the prospect of profits from cleaner and more fuel-efficient technology can help to spur innovation and investment. But to meet net zero targets still requires policies that are unpopular with many people who might be inconvenienced or have to pay higher petrol, energy and food prices, especially at a time when budgets are being squeezed by inflation.

Part of the problem is a distributional one. The people most affected by the cost-of-living crisis and higher interest rates are those on lower incomes and with higher debts. Politicians know that it will be hard to win the votes of such people if they are faced with higher green taxes. As elections approach, politicians are likely to backtrack on many environmental commitments to appeal to such people.

This is beginning to happen in the UK, with the government declaring that it is on the side of the motorist. Indeed, Rishi Sunak has just announced that the government will authorise more than 100 new licenses for new oil and gas wells in the North Sea. This is despite the United Nations, various other international bodies, climate scientists and charities calling for a halt to all licensing and funding of new oil and gas development from new and existing fields. The government argues that increased North Sea production would reduce the reliance on imported oil.

Video

Articles

Questions

  1. In what sense is the environment a ‘public good’? How is the concept of externalities relevant in analysing the private decisions made about the use of a public good?
  2. How may game theory be used to help understand the difficulties in reaching international agreement about climate change policies?
  3. What is meant by ‘net zero’? Is carbon capture and storage an acceptable alternative to cutting carbon emissions?
  4. In what ways could policies to tackle climate change be designed to reduce income inequality rather than increase it?
  5. What are the arguments for and against banning (a) petrol and diesel cars; (b) gas boilers; (c) fossil-fuel power stations? How much notice should be given if such bans are to be introduced?
  6. What is meant by ‘nudge theory’? In what ways could people be nudged into making greener decisions?
  7. What are the arguments for and against granting new licences for North Sea oil and gas drilling? Explain where you feel the balance of the arguments lies.
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Monetary policy: too much, too late?

In this third blog about inflation, we focus on monetary policy to deal with the problem and bring inflation back to the target rate, which is typically 2 per cent around the world (including the eurozone, the USA and the UK). We ask the questions: was the response of central banks too timid initially, meaning that harsher measures had to be taken later; and will these harsher measures turn out to be excessive? In other words, has the eventual response been ‘too much, too late’, given that the initial measures were too little?

Inflation rates began rising in the second half of 2021 as economies began to open up as the pandemic subsided. Supply-chain problems drove the initial rise in prices. Then, following the Russian invasion of Ukraine in February 2022 and the adverse effects on oil, gas and grain prices, inflation rose further. In the UK, CPI inflation peaked at 11.1% in October 2022 (see chart 1 in the first of these three blogs). Across the whole EU-27, it peaked at 11.5% in October 2022; US inflation peaked at 9.1% in June 2022; Japanese inflation peaked at 4.3% in January 2023.

This raises the questions of why interest rates were not raised by a greater amount earlier (was it too little, too late?) and why they have continued to be raised once inflation rates have peaked (is it too much, too late?).

The problem of time lags

Both inflation and monetary policy involve time lags. Rising costs take a time to work their way through the supply chain. Firms may use old stocks for a time which are at the original price. If it is anticipated that costs will rise, central banks will need to take action early and not wait until all cost increases have worked their way through to retail prices.

In terms of monetary policy, the lags tend to be long.

If central bank interest rates are raised, it may take some time for banks to raise savings rates – a common complaint by savers.

As far as borrowing rates are concerned, as we saw in the previous blog, loans secured on dwellings (mortgages) account for the majority of households’ financial liabilities (76.4% in 2021) and here the time lags between central bank interest rate changes and changes in people’s mortgage interest rates can be very long. Only around 14 of UK mortgages are at variable rates; the rest are fixed, typically for between 2 to 5 years. So, when Bank Rate changes, people on fixed rates will be unaffected until their mortgage comes up for renewal, when they can be faced with a huge increase in payments.

Only around 21% of mortgages in England were/are due for renewal in 2023, and with 57% of these the old fixed rates were below 2%. Currently (July 2023), the average two-year fixed-rate mortgage rate in the UK is 6.81% (based on 75% loan to value (LTV)); the average five-year rate is 6.31% (based on 75% LTV). This represents a massive increase in interest rates, but for a relatively small proportion of homeowners and an even smaller proportion of total households.

But as more and more fixed-rate mortgages come up for renewal, so the number of people affected will grow, as will the dampening effect on aggregate demand as such people are forced to cut back on spending. This dampening effect will build up for many months.

And there is another time lag – that between prices and wages. Wages are negotiated periodically, normally annually or sometimes less frequently. Employees will typically seek a cost-of-living element in wage rises that covers price rises over the past 12 months, not inflation in the past month. If inflation is rising (or falling), such negotiations will not reflect the current situation. There is thus a time lag built in to such negotiations. Even if higher interest rates reduce inflation, the full effect can take some time because of this wages time lag.

Other time lags include those involving ongoing capital projects. If construction is taking place, it will take some time to complete and in the meantime is unlikely to be stopped. Higher interest rates will affect capital investment decisions now, but existing projects are likely to continue to completion. As more projects are completed over time, so the effect of higher interest rates is likely to accumulate.

Then there is the question of savings. During the pandemic, many people increased their savings as their opportunities for spending were more limited. Since then, many people have drawn on these savings to fund holidays, eating out and other leisure activities. Such spending is likely to taper off as savings are reduced. Again, the interest rises may prove to have been excessive as a means of reducing aggregate demand.

These time lags suggest that after some months the economy will have been excessively dampened and that the policy will have ‘overshot’ the mark. Had interest rates been raised more rapidly earlier and by larger amounts, the peak level of rates may not have needed to be so high.

Perhaps one of the biggest worries about raising interest rates excessively because of time lags is the effect on corporate and government debt. Highly indebted companies and countries will find that a large increase in interest rates makes servicing their debt much harder. For example, Thames Water, the UK’s biggest water and sewerage company accumulated some £14 billion in debt during the era of low interest rates. It has now declared that it cannot service these debts and is on the brink of insolvency. In the case of governments, as increasing amounts have to be spent on servicing their debt, so they may be forced to cut expenditure elsewhere. This will have a dampening effect on the economy – but with a time lag.

The distribution of pain

Those with large credit-card debt and large mortgages coming up for renewal or at variable rates will have borne the brunt of interest rate rises. These people, such as young people with families, are often those most affected by inflation, with a larger proportion of their expenditure on energy and food. Other people adversely affected are tenants where landlords raise rents to cover their higher mortgage payments.

Those with no debts will have been little affected by the hike in interest rates, unless the curbing of aggregate demand affects their chances of overtime or reduces available shifts or, worse still, leads to redundancy.

Excessive rises in interest rates exacerbate these distributional effects.

Articles

Questions

  1. For what reasons might a central bank be unwilling to raise interest rates by more than 0.25 or 0.5 percentage points per month?
  2. What instruments other than changing interest rates does a central bank have for influencing aggregate demand?
  3. Distinguish between demand-pull and cost-push inflation.
  4. Why might using interest rates to curb inflation be problematic when inflation is caused by adverse supply shocks?
  5. How are expectations of consumers and firms relevant in determining (a) the appropriate monetary policy measures and (b) their effectiveness?
  6. How could a careful use of a combination of monetary and fiscal policies reduce the redistributive effects of monetary policy?
  7. How might the use of ‘forward guidance’ by central banks reduce the need for such large rises in interest rates?
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Tackling climate change: ‘Everything, everywhere, all at once’

The United Nations International Panel on Climate Change (IPCC) has just published its most comprehensive report so far. It finds that ‘human activities, principally through emissions of greenhouse gases, have unequivocally caused global warming’. This has led to widespread and rapid changes in climate and biodiversity and to more extreme weather patterns, such as droughts, floods and hurricanes. What is more, the distribution of these effects is uneven, with communities who have contributed the least to current climate change being disproportionately affected.

At the 2015 COP21 climate change conference in Paris (see also), it was agreed to adopt policies to limit the increase in global temperatures to ‘well below’ 2°C above pre-industrial levels and to make an effort to limit it to 1.5°C. Global temperatures have already risen 1.1°C above 1850–1900 levels and are set to reach 1.5°C in the early 2030s. Every increment of global warming will intensify ‘multiple and concurrent hazards’.

Deep, rapid and sustained reductions in emissions would slow down the rise in global temperatures, but even with such reductions, temperatures will still exceed 1.5°C in the next few years and, even under the best-case scenario, would not fall below 1.5°C again until the end of the 21st century. Under more pessimistic scenarios, global temperatures could rise to 2.7°C above pre-industrial levels by the end of the century under an intermediate greenhouse gas emissions scenario and to 4.4°C under a very high emissions scenario. Anything above 2°C would be likely to have catastrophic effects. The longer countries wait to take action, the greater the rise in global temperatures and hence the greater the damage and the more costly it will be to rectify it.

‘For any given future warming level… projected long-term impacts are up to multiple times higher than currently observed (high confidence). Risks and projected adverse impacts and related losses and damages from climate change escalate with every increment of global warming (very high confidence). Climatic and non-climatic risks will increasingly interact, creating compound and cascading risks that are more complex and difficult to manage (high confidence).’ (Paragraph B2)

But the report is not all ‘doom and gloom’. It is possible to limit global warming to 1.5°C or only a little over by making rapid, deep and, in most cases, immediate greenhouse gas emissions reductions in all sectors and reaching net zero emissions in the early 2050s. Science and technology have the answers – answers that are now much cheaper and more available than back in 2015 when the 1.5°C target was agreed. But what it does require is doing ‘everything, everywhere, all at once’. And that requires political will and the right economic incentives.

The politics and economics of achieving net zero

In terms of the politics, there is general global agreement by governments about the likely effects of climate change. And most governments agree that action needs to be taken. However, there are three key political problems.

The first is that the costs of action will be borne now, while the benefits of action will accrue over a much longer period of time. This links to the second problem – the mismatch between the lives of governments and the long-term effects of climate change. If governments put off doing anything now and merely promise that something will be done in the future, they will not have to take unpopular actions, such as raising taxes on energy, private transport and certain goods or banning various activities. Future governments will have to sort things out, by when, although the problems will be greater, the existing politicians will no longer be in power.

The third problem concerns the distribution of the costs and benefits of action. The major emitters of carbon are the rich countries, while the major sufferers are poor people in countries subject to drought, flooding and rising sea levels. Not surprisingly, who should cut down on emissions and pay for the mitigation necessary in many of the poorer countries is a difficult political issue, which is why it’s much easier to say what needs to be achieved overall than precisely what measures should be taken by which countries.

These problems reflect the fact that many, if not most, of the environmental costs of production and consumption are external costs – costs borne, not by the direct producer or consumer, but by other people at other places and/or in the future.

Nevertheless, the relative costs of moving to greener production and consumption are falling. The costs of renewable energy, including solar power, onshore and offshore wind and hydroelectric power are falling relative to that generated from fossil fuels. At the same time, the take up of electric cars is likely to continue rising as battery technology improves. This does, of course, require an increase in charging infrastructure. Domestic heat pump technology is improving and home insulation methods are becoming more efficient.

Persuading consumers and firms to take account of environmental externalities could in part be achieved by education. It makes it much easier for politicians to take appropriate action now if their populations are on board. There has been increasing awareness over the years of the environmental impact of people’s actions. People have become more willing to take responsibility for the world that future generations will inherit. This is helped both by education in schools and colleges and by frequent items in the media.

But incentives also have a major part to play. To internalise environmental externalities, external costs could be taxed and external benefits subsidised.

The effect of a carbon tax on production

The use of taxes to reduce activities with negative environmental externalities is illustrated in the diagram (click here for a PowerPoint). It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.

It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).

Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P0 while the market equilibrium quantity is Q0. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.

The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q0 > Q*. From society’s point of view, too much electricity is being produced and consumed.

If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers’ interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.

But this brings us back to the politics of measures to reduce emissions. People do not like paying higher taxes. In his latest Budget, the UK Chancellor, Jeremy Hunt, decided not to raise fuel duties by the 12p that had been previously planned, despite fuel prices having recently fallen. Meanwhile, charging prices for electric cars have risen.

Other economic measures

A simpler method for dealing with environmental externalities is ban certain activities that omit CO2. For example, in the UK there will be a ban on the sale of new petrol and diesel cars and vans from 2030 (with the exception of some low-emission hybrids until 2035). In the EU there will be a similar ban from 2035. Clearly, such measures are only suitable when there are non-emitting alternatives.

Another alternative is a cap-and-trade system, such as the European Emissions Trading Scheme. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the ‘cap’) must be sufficiently tight if emissions are going to be cut to desired levels. Nevertheless, it is an efficient way of cutting emissions as it gives a competitive advantage to low-emission producers.

Conclusion

If the problem of global warming is to be limited to 1.5°C, or only very little above, multiple solutions will need to be found and there must be a combination of political will, economic incentives and the mobilisation of scientific and technical know-how. As the Secretary-General of the United Nations, António Guterres, stated in launching the new report:

This report is a clarion call to massively fast-track climate efforts by every country and every sector and on every timeframe. In short, our world needs climate action on all fronts – everything, everywhere, all at once.

Report

Videos

Articles

Questions

  1. Why might countries not do ‘everything, everywhere, all at once’ to avert climate change?
  2. What might an optimist conclude from the ICC report?
  3. To what extent is climate change an economic problem?
  4. On a diagram similar to the one above, show how a subsidy could be used to internalise positive externalities.
  5. How might countries reduce the consumption of fossil fuels in the most efficient way? Are they likely to want to do this? Explain.
  6. Is a ‘cap-and-trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?