Gasoline Price Uncertainty and the Design of Fuel Economy Standards

Summary:

• Automotive fuel efficiency standards are the principle policy for reducing fuel use and carbon dioxide emissions in the U.S. transportation sector. The current standards were implemented in 2010 and 2012 and are designed to remain in place through 2025.
• Fixed standards such as these are highly inflexible, and their cost-effectiveness and efficiency in reducing emissions is directly dependent on gasoline prices. If gasoline prices are higher than expected at the time the rules are written, consumers will opt for vehicles that are even more efficient than the rules require, suggesting that the rules are too lenient and are missing out on large emissions savings. If prices are lower than expected, consumers will demand less efficient vehicles, raising compliance costs for automakers.
• This study finds that because gasoline prices are highly volatile, a superior approach would be a price-based policy indexed to the price of gasoline. When gasoline prices are high, the standards would ratchet up to become binding, achieving maximum, costeffective fuel and emissions savings. When gasoline prices are low, the standards would ratchet down, avoiding overly burdensome costs for automakers.
• A more flexible standard would allow automakers to adjust vehicle production volumes to more closely match consumer preferences—for example, by manufacturing fewer small models when gasoline prices are lower than expected and more small models when gasoline prices are higher than expected. This would not entail changing product portfolios, at least in the short run, but rather adjusting production of existing products to match consumer preferences. In the longer run, a flexible standard could accommodate manufacturers’ ability to adjust the fuel economy of their models in response to changes in consumer demand, though it would be important to ensure that the standards only adjust incrementally to avoid implementing standards in a given year for which automakers had not produced suitable vehicles.
• Adjustable fuel-economy standards could be designed such that they never fall below the level dictated by the expected cost of carbon damages, and only adjust modestly within a relatively narrow band. This approach would ensure maximum, cost-effective emissions reductions.