“Now, in sulfur dioxide emissions, that works pretty well. We know where those emissions are: primarily power generation plants. We can measure the emissions and cut them back. And the effects are relatively local.

“With carbon, the problem is too broad, too big, for a rational application of cap and trade. Everyone is using carbon. Well, if everyone has to look to these carbon contracts then it will open the market to the biggest market test of the contract design.

“Moreover, we learned with sulfur dioxide that if Congress or other policymaking bodies are involved in manipulating the market it can cause tremendously disruptive policy shocks that will have potentially debilitating effects on the price of the externality you’re putting out to market. That happened with a sulfur dioxide court challenge on whether policy could withstand a legal test. Contract prices went wild during that period and almost killed the market notwithstanding the court decision, which supported the market. That’s a window into the effects that policy shocks can have on such markets.

“Having learned these lessons, I think the Greens have rationally retreated from promoting this institutional-designed carbon market. Like I said, France has moved away from relying solely on cap and trade.

“As we speak, I think we are seeing a sea change in thinking on carbon. It’s ill-advised for Congress to ignore that.”

Chances for climate change legislation to pass Congress this year?

“I get the impression nothing will pass this year. Depending on how the Obama administration handles its other big policy problems – healthcare and the financial crisis – we may see something bubble up on climate legislation next year.

“But it seems to me that as time goes on and the debate becomes more complex, the policy risks being lost. And that, perhaps, could be the case for many years hence.

“When we constructed the U.S. Federal Reserve System, Congress undertook an investigation through the National Monetary Commission. That was to study in-depth the applications of central banks around the world. That took a bit over seven years and is still the best study of central bank design features ever performed.

“Before this climate legislation is finished, I could see a similar delay – five, seven, maybe 10 years – before cap and trade passes out of Congress.

“I certainly hope we’ll see some kind of even minor tax placed on carbon in the meantime. I think there are very real concerns about carbon emissions. Whether or not you’re a doom-and-gloomer, I think restrained carbon emissions are good for the environment, for the economy and promote efficient production. There’s nothing wrong with nudging incentives, as a carbon tax could as early as next year.”