Climate Change and Growth Risks

To study the welfare implications of rising temperature we propose a temperature-augmented long-run risks model that accounts for the interaction between temperature, economic growth and risk. The model simultaneously matches the projected temperature path, the observed consumption growth dynamics, discount rates provided by the risk-free rate and equity market returns, and the negative elasticity of equity prices to temperature risks documented in the data. We use the calibrated model to quantify the social cost of carbon (SCC) and to frame the optimal climate policy. We show that a preference for early resolution of uncertainty and long-run impact of temperature on growth imply a significant SCC and motivate early actions to abate global warming.