Ten years ago this summer, President Clinton’s Council of Economic Advisers, of which I was a Member, responded to requests from the Congress, which was then under Republican control, to explain in analytical terms what would be the economic effects of the Kyoto Protocol on climate change that had just been negotiated among the members of the UN Framework Convention on Climate Change. Our response was a document called the Administration Economic Analysis. It relied on some of the leading Integrated Assessment Models, and showed that the costs of Kyoto could be relatively low provided international trading of emission permits were freely allowed, and provided developing countries participated in the system. Not zero costs, as wishful thinking by some techno-optimists would have it. Not prohibitive costs, as some skeptics would have it. But moderate costs — relatively low if measures could be implemented sensibly.
Integrated Assessment Models are designed to assess both the economic costs and the environmental benefits of action to reduce emissions of greenhouse gases. For 15 years, the Energy Modeling Forum (EMF), under the leadership of John Weyant at Stanford University, has periodically brought together the modelers to compare results and exchange ideas. It was gratifying when we discovered that the economic model we had used to estimate costs was near the middle of the pack of ten leading academic models according to the EMF, in terms of the estimated impact on energy costs for example, contrary to suspicions that we must have low-balled the estimates.
Exactly ten years ago, in August 1998, I attended the Energy Modeling Forum’s annual workshop in Snowmass, Colorado, Climate Change Impacts and Integrated Assessment. My assignment then was to explain the Administration Economic Analysis to this group. Unlike most American economists, I believe that something along the lines of the Clinton-Gore version of Kyoto offers the most promising path to address the problem of Global Climate Change.
A lot has changed in ten years. Popular awareness and support is much stronger now. Serious legislation to cap US emissions almost passed the Congress last spring. Both of the current presidential candidates say they support serious action to address greenhouse gas emissions — although they have trouble reconciling this position with their desire to respond sympathetically to popular displeasure over high energy prices.
I returned to the EMF Workshop a few weeks ago (July 28-August 1). My assignment this time was to try to answer the modelers’ question what they could do to make their research of maximum relevance and usefulness to Washington policy-makers.
The Energy Modeling Forum has just posted on its website the presentations from this year’s Snowmass workshop. I remain highly impressed with the EMF and this community of scholars. They have made a lot of progress over the last ten years. They are pursuing research at its best: a good combination of unbiased science, healthy rivalry among teams, fruitful collaboration, and dedication to figuring out the most accurate possible answers to one of the most critical policy questions of our time, unencumbered by ideology. The climate change modelers genuinely cut across disciplinary boundaries, an accomplishment that is always sought by Deans and Foundations but is seldom realized in practice.
Quite a few economists are worried about moral hazard in financial markets. Vince Reinhart wrote a Wall Street Journal column rebuking his former bosses after the Bear Stearns intervention: “…the Federal Reserve’s action can only be viewed as rewarding bad behavior.” Ken Rogoff recently wrote in a Financial Times column, “it is important to be tougher in busts, so that investors and company executives have cause to pay serious attention to risks. If poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail?”
Of course moral hazard is a serious problem that lies close to the heart of the financial market crises. But I am not sure that I completely share the priority at this point on drawing a tougher line with the ex post bailouts. It may be futile advice. Fixing the hole in the roof when it is raining is, after all, rather difficult.
Consider two other areas where moral hazard is an issue: commercial banks and river banks. Some economists would prefer that the government refrain from helping the victims of banking panics and river floods, respectively. The worry is that if those who overlend or overbuild do not bear the full costs of their mistakes, they will have no incentive to be more careful in the future.
But I think we figured out some time ago that in practice no democratic government will ever ex post turn its back on poor shivering families who appear on TV huddled in front of the ruins of their flooded out homes (or banks). It is wiser that we recognize this fact, and design a regulatory system that explicitly incorporates mandatory federal flood insurance and deposit insurance, and charges for them up front. We already do this for commercial banks. To me, the lesson of recent months is that we need to do it for a wider range of financial institutions.
As a final tweak, I can’t help noting that central bank governors, Treasury secretaries, and chief executives who make the most noise about the evils of moral hazard and bailouts ex ante, are no more likely to stand firm ex post than others. If anything, the reverse. I am thinking, for example, of how – ten years ago this month – it was the Clinton Administration that finally pulled the plug on continued IMF loans to Russia, despite well-founded fears of systemic contagion. The Reagan Administration in the 1982-84 international debt crisis and the Bush Administration in the 2001-03 Argentine crisis, for all their laissez-faire rhetoric, never pulled the plug on any of the debtor countries. When sitting in the hotseat of a financial crisis, officials suddenly discover a need for bailouts, much like soldiers sitting under fire in foxholes sometimes suddenly discover a need for religion.