Tradable pollution permits in dynamic general equilibrium: can optimality and acceptability be reconciled?

In this paper we study the optimal growth path and its decentralization in a two-sector overlapping- generations model with pollution. One sector (power generation) is polluting and the other (final good) is not. Pollution is regulated by tradable emission permits. The issue is whether the optimal growth path can be replicated in equilibrium with pollution permits, given that some permits must be issued free of charge for the sake of political acceptability. We provide a policy rule that allows optimality and acceptability to be reconciled.