Precautionary Policy Rules in an Integrated Climate-Economy Differential Game with Climate Model Uncertainty

The paper introduces structural uncertainty in an integrated climate-economy differential game such that the probability distribution of climate sensitivity is unknown. This is generated by perturbing a continuous-time version of the climate model in Nordhaus (1992) and Nordhaus and Yang (1996). Instead of analyzing choices of regional representative consumers, we define social profit from regional production as the payoff to regional policymakers. There are two types of players: Firstly, regional policymakers $j=1,2,\dots,N$, who are tied to a region by acting as a sovereign regional social planner who can only enforce regional emissions reduction policies. Secondly, investors $i=1,2,\dots,n$, who are not tied to any region who allocate investments between firms (production processes generating emissions) located in all regions $j=1,2,\dots,N$. We identify policymakers' optimal policy responses to firms' investment responses as well as firms' optimal investment responses to policymakers' policy responses in a global subgame perfect Nash equilibrium when policymakers do not cooperate and compare it to when policymakers coordinate national policy rules.