Optimal Climate Policy with Demographic Transitions

Abstract This paper develops a framework to integrate demographic change into climate policy analysis. We build an overlapping-generations climate-economy model with a rich demographic structure, allowing population growth and survival probabilities to vary over time. These features endogenously determine the age composition of society and shape aggregate preferences. A central result of our framework is an aggregation result: despite the heterogeneity across cohorts, the planner’s problem can be recast as a representative-agent model with a time-varying social discount factor that reflects demographic dynamics. Notably, as the population ages, the discount factor declines, causing society to behave as if it were more impatient. We use this framework to study how current global demographic trends affect the social cost of carbon—the model-based measure of the economic cost of climate change. We find that this cost is significantly higher under medium- and high-fertility scenarios, driven by greater emissions from larger populations. These effects are partially offset by higher discounting in ageing societies. Relative to a benchmark model with no demographic change, the initial social cost of carbon rises by 20% under medium fertility and by 57% under high fertility. Global temperatures also increase more sharply in these scenarios, suggesting that demographic trends will exacerbate the climate problem.