Optimal Renewable Energy Policies under Uncertainty: Commitment vs. Discretion
When promoting the large-scale deployment of renewable energy sources (RES), policy-makers face substantial uncertainties, particularly regarding the corresponding future policy costs and benefits. Currently chosen subsidies to stimulate RES deployment may therefore turn out to be ill-designed in the long-run. As a response, RES policies may need to be adjusted over time to account for new information about RES impacts and benefits. However, discretionary RES policy may also open up for time-inconsistent policy-making: If RES investments are sunk and if there are policy objectives competing with environmental protection, such as limiting the social burden from funding RES policies, policy makers may have an incentive to reduce the future RES subsidies below the intertemporally optimal rate. Private RES investors will foresee such policy adjustments and may hold-up irreversible RES investments. Thus, the expectation of future policy adjustments may impair the efficient internalization of external benefits of RES deployment. Against this background, this paper explores the optimal long-term design of RES policies. Should policy-makers be committed to a pre-defined long-term RES policy pathway? Or should they be allowed the discretion to adjust the policy framework if necessary?
To answer these questions, we develop a dynamic partial equilibrium model which allows examining optimal RES policy options in the presence of path-dependent investments in RES technologies and uncertainty of benefits from RES deployment. Our analysis shows that commitment to state-conditional RES subsidies outperforms both unconditional commitment as well as full discretion. The choice between unconditional commitment and full discretion is analytically ambiguous. However, a numerical application illustrates that full discretion is superior to unconditional commitment for reasonable parameter values – and may in fact perform almost as good in terms of overall welfare as state-conditional subsidies.