Policy Options to Stabilize the Carbon Price within the European Emissions Trading System : Framework for a Comparative Analysis

This paper develops a methodology aimed at assisting policymakers in selecting the optimal policy option to support the carbon price within the ETS. We consider different policy proposals that can support the carbon price either by intervening on the ETS cap (-30%, set-aside, carbon central bank, long-term reduction targets) or directly on the carbon price (national and EU price floor). In detail, each proposal is examined according to six criteria that allow us to capture and compare their economic, regulatory and procedural implications, so as to determine which options would not only be feasible but also most effective. We conclude that the introduction of a price stabilization mechanism allowing for a reversible adjustment of the ETS cap according to clear, pre-defined rules by an independent authority such as a carbon central bank would be the most effective option to reduce not only the current shortcomings of the ETS but also reinforce the mechanism to avoid similar problems in the future. The establishment of a EU-wide price floor, would represent a second-best solution. The worst options appear to be those involving an overall increase in target reduction to 30% and a price floor in its national version, as currently implemented in UK. Finally, we conclude that the setting of post-2020 targets is not a mutually exclusive option, and could be adopted in any case to increase the regulatory certainty of the system