by the Congressional Budget Office

“ When models with adaptive expectations are used to estimate the costs of a tax on emissions or a permit system, they tend to produce somewhat higher cost estimates than models with forward-looking expectations, all else being equal. That happens because people in forward-looking models have time to adapt to any policy that is announced in advance. Modelers who use adaptive expectations adjust for that limitation by gradually phasing in the policy, to simulate the anticipation of forward-looking individuals. ”

“ For example, the Energy Information Administration’s National Energy Modeling System integrates a set of models of particular energy sectors, a national macroeconometric model, and an international econometric model. Other frameworks add models of the agriculture and forestry sectors to simulate flows of carbon dioxide and methane in those areas of the economy. Models that treat in detail the economy’s energy- or carbon-intensive subsectors tend to provide greater insight into those sectors’ responses to climate policies than do less complex approaches. ”

“ Types of Models Economic analyses yield a wide range of cost estimates for a given climate change mitigation policy, but most of the variation in results is due to identifiable differences in the approaches and assumptions that the studies use. Many analyses use one of several "top-down" approaches that represent the entire economy in an internally consistent way: they account for more or less all production and consumption; inputs of capital, labor, and energy ”

“ Nevertheless, analysts have often failed in the past to anticipate technological advances that seem fairly obvious in retrospect, such as the relatively rapid development of the Internet in the 1990s, or—an innovation that is closer to the issue of climate change—the adoption of natural-gas-powered combined-cycle electricity generation. ”

“ In contrast, the assumption of forward-looking behavior, which is used in a number of sectoral and general-equilibrium models, yields forecasts in which people perfectly anticipate all developments. Both assumptions are extreme, and they yield significantly different results. ”

“ Top-down approaches allow researchers to account for many of the indirect economic effects of climate change policies that would primarily affect markets for energy; but they often ignore important details involving the gradual turnover of energy-using equipment, the choice of equipment, energy market barriers, and other factors. ”

“ Forecasting the use of particular technologies for the near to medium term is relatively straightforward, for two reasons: much of the capital stock (especially energy-using capital) lasts a long time, and innovations usually take a fairly long time to make their way into the market. ”

“ As forecasters look forward over two or more decades, their ability to anticipate technological developments becomes increasingly weak.
Most models represent the pace and direction of technological change in a fairly simple way because the underlying forces of change are not well understood. ”

“ Those estimates are derived mainly from a variety of computer models of economic activity that have been developed for other purposes and adapted to climate policy analysis. The variety of analytic approaches used makes it difficult even for modelers to interpret the differences among results from different studies. Researchers and policymakers are forced to integrate information from many sources and develop a synthesis based on a range of studies and approaches, each of which provides insight into some aspects of the problem while ignoring others. ”

“ Such a model can be used to analyze how changes in energy prices might encourage more or less use of energy, relative to the autonomous trend. Somewhat more complex models extend that basic process by projecting a menu of technologies that are expected to be available in the future and then analyzing how changes in energy prices would encourage people to switch to more energy-efficient types of equipment. ”

“ Virtually no model simulates the effect of energy prices on the autonomous trend or on the menu of available technologies. Although the size of that so-called inducement effect is controversial, cost estimates that ignore it probably overestimate the incremental cost of reducing emissions over the longer run—say, 20 years or more. ”