In an ideal world without uncertainty, policy-makers should use a range of policies to reduce greenhouse gas emissions, but the core policy should be to price carbon emissions at the level of the marginal cost of carbon emissions, or equal to the social cost of carbon emissions. However, the real world is highly uncertain. Uncertainty regarding climate science, the economic impact of climate change, and appropriate discount rates across generations all complicate estimates of the social cost of carbon emissions.
In response to climate uncertainty, researchers, businesses, and policy-makers are turning to scenario analysis. The use of scenarios is critical for policy design because of the extent of uncertainty and the highly dynamic nature of the system. Policies must adapt to new information on the changing climate, emergent technologies, and the reactions of the economy. However, to effectively use scenarios, policy-makers need to understand how scenarios are developed and the strengths and weaknesses of the different modelling approaches.
This policy brief has two goals. The first is to inform policy-makers about existing scenario approaches and how scenarios that are applied to large-scale models should be used first to understand the nature and scale of possible climate shocks and then develop and evaluate alternative policy approaches to respond to climate change.
The second goal of the paper is to draw some policy conclusions for climate policy design that have emerged from recent scenario exercises. There are significant climate risks with potential large economic costs, such as physical risk from chronic climate change and extreme climate events, as well as shocks to economies from changes in climate policies (transition risk).