Pollution permits and policy constraints in an interlocking generations model.

Summary We propose a nested-generation model in which firms' polluting emissions are regulated by a system of pollution permits. The global emission quota is imposed on the economy and is accompanied by political constraints on its use. In this context, the question arises whether pollution regulation by permits and the achievement of the first-order optimum are compatible. We show that when policy is constrained, it is possible to establish the optimality of the equilibrium thanks to a policy of redistribution of the environmental rent and a policy of price discrimination of the participants (firms and households) on the permit market.