Intertemporal modeling: computable general equilibrium and environmental applications

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Fawcett, Allen Atchison

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The first chapter uses an intertemporal optimal control model to analyze the problem of transboundary pollution that has both stock and flow characteristics. In this theoretical model, firms produce a flow pollutant that adversely affects the state in which it was released and downstream states. The pollution can be cleaned-up by removing the damaging elements from the flow before they enter the environment, but the removed harmful elements do not simply disappear. Their disposal generates a stock pollutant that only affects the state in which it was generated. The model is solved for the optimal time path for cleanup of the flow pollutant, and the Pigouvian tax rate that will achieve the optimal result. In a transboundary setting, regulation chosen by the upstream polluting state will clean up less than the optimal amount of flow pollutant. The model also demonstrates that a federal regulation that ignores the stock pollutant will clean up more than the optimal amount of the flow pollutant. The second chapter presents an econometrically-estimated intertemporal computable general equilibrium model with labor and capital adjustment costs. Computable general equilibrium models are widely used for evaluating policies, but they generally fail to capture short run rigidities, especially in labor markets. This shortcoming has led to the continued use of old style reduced-form macro models for policy analysis in situations where short-run rigidities are likely to be important. Capturing labor market rigidities is particularly important in the analysis of environmental regulations or other policies that strongly affect narrow sections of the economy. In the long run, the industries adversely affected by such policies will shrink. In the short run, however, the labor employed in those industries is not able to move. The true cost of such a policy, therefore, depends critically on the transition path of the economy from the announcement of the policy to the new long run equilibrium. Including labor adjustment costs addresses this problem and will allow computable general equilibrium models to be used for a much broader range of policy analyses than they have been in the past.