Abstract

We explore the effect of raising economic uncertainty on local and global carbon emissions. Most economic models under uncertainty focus on the effect of risk on the supply of a control variable (e.g., emissions). Here we explore the effect of risk on both the supply and demand of local and global carbon emissions and, therefore, on their equilibrium shadow price. We show that in addition to the consumers’ level of risk aversion and prudence coefficient, an additional parameter not included in standard models, the elasticity of substitution between pollution and conventional inputs, plays a key role as a determinant of local and global emissions. An important implication of the analysis is that, under various specifications widely used for preferences and production technologies, a damning vicious cycle between increasing economic uncertainty and global pollution emissions is likely to occur.