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Scenario 1

Government purchases emissions units from offshore, financed by higher personal income tax. From MFE net position report, the amount involved is $228m per annum, being 9.1 Mt CO2 at $25/tonne.

Given no deterioration in the balance of payments, the additional offshore payments by government need to be offset by an increase in the balance of trade in goods and services. of $228m.

As shown in Table 1 exports rise by 0.4% and imports fall by 0.2%, as does private consumption. The main mechanism at work here is the 0.2% reduction in the real exchange rate which enables exporters to sell more quantity, albeit at lower average prices – a movement down the export demand curves. The terms of trade fall by 0.2%.

Note that the model does not simulate the absolute level of prices. It deals only with relative prices. Thus a reduction in the real exchange rate could be manifested as either a devaluation of the nominal exchange rate or as lower nominal domestic prices and wages. Either way the international purchasing power of New Zealand households falls. Measured in world prices GDP declines by 0.2% relative to BAU.

Table 1 - Macroeconomic Results

 

BAU

Scenario 1
Govt responsible for all emissions

Scenario 2
ETS $25/tonne. Free allocation to industry

Scenario 3
ETS $50/tonne. Free allocation to industry

Emission units required to be purchased off shore (p.a)

 

9.1Mt

6.8Mt

5.2Mt

Private Consumption

 

-0.2%

-0.2%

-0.3%

Exports

 

0.4%

0.0%

-0.1%

Imports

 

-0.2%

-0.2%

-0.4%

GDP in world prices2

 

-0.2%

0.0%

0.0%

Real wage rate

 

0.1%

-0.2%

-0.5%

Household average tax rate

 

1.4%

-1.0%

-2.4%

Real exchange rate

 

-0.2%

0.0%

0.1%

Terms of Trade

 

-0.2%

0.1%

0.1%

CO2emissions (Gg)

37964

0.0%

-5.9%

-10.1%

Agriculture CH3& N2O

43715

0.1%

0.0%

0.0%

Total (Gg)

81679

0.1%

-2.7%

-4.7%

One might wonder about the low national cost – at just 0.2% of private consumption, but the size of the ‘shock’ is not particularly large. Over the period 2008-2012 the ETS will apply almost exclusively to carbon dioxide, emissions of which in 2012 are projected in the BAU scenario at 38 Mt. The future price of carbon is unknown, but at $25/tonne the value of emissions is about $950 million. New Zealand’s gross domestic product will be over $200 billion by 2012. Thus the proportion of GDP accounted for by the value of emissions is less than 0.5%. But this portion of GDP does not just disappear. Indeed, the only bits that disappear are:

  1. the resources required to pay for the emission rights that New Zealand must purchase on the international market (analogous to giving away some of our exports);
  2. the deadweight loss that is generated by the higher taxation required.

In fact (1) does not actually cause a reduction in the volume of goods and services produced by New Zealand. It is simply that more resources need to go into exporting, leaving less for private consumption. So, lower private consumption is the manifestation of (1).

2 GDP in world prices is considered to be a better indicator of GDP in this case, than if specified in NZ$, because it includes the effect of changes in New Zealand’s real exchange rate.

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