Discounting the distant future: How much does model selection affect the certainty equivalent rate?

Energy Policy, 1999

This paper confronts the theory of discounting with Climate Change economics. Standard discounting would give long-term damages a very low present value. On the other hand, low discount rates would imply more sacrifices for present generations, although future generations may be richer. And using multiple rates would lead to economic inefficiencies. The paper first shows that arguments favouring a low or zero discount rate in general are weak, even from an ethical point of view. It goes on by considering different arguments in favour of discount rates decreasing over time, and by recalling the argument that nonreproducible environmental assets should be given a value growing over time. Through the example of climate change, it finally shows that the latter argument not only implies that the costs of damages associated to Climate Change should not be underestimated, but also reinforce the legitimacy of using decreasing discount rates.

2007

Time perspective – the tendency to foreshorten time units as we peer further into the future – implies hyperbolic discounting. We study implications of hyperbolic discounting for climate change policy, using a model in which the probability of a climate-induced catastrophe depends on the stock of greenhouse gasses (GHG). We characterize the set of Markov perfect equilibria of the intergenerational game in which each generation can either do nothing or stabilize atmospheric GHG concentration, and compare this set to a “restricted commitment” benchmark. We calculate the associated “constant equivalent discount rates” and the corresponding levels of expenditure to control climate change, and compare these results to discounting assumptions and policy recommendations in the Stern Review on Climate Change. “. . .My picture of the world is drawn in perspective. . . I apply my perspective not merely to space but also to time” –Ramsey.

SSRN Electronic Journal, 2022

Integrated assessment models have become the primary tools for comparing climate policies that seek to reduce greenhouse gas emissions. Policy comparisons have often been performed by considering a planner who seeks to make optimal trade-offs between the costs of carbon abatement and the economic damages from climate change. The planning problem has been formalized as one of optimal control, the objective being to minimize the total costs of abatement and damages over a time horizon. Studying climate policy as a control problem presumes that a planner knows enough to make optimization feasible, but physical and economic uncertainties abound. Manski, Sanstad, and DeCanio (2021) proposed and studied use of the minimax-regret (MMR) decision criterion to account for deep uncertainty in climate modeling. Here the authors study choice of climate policy that minimizes maximum regret with deep uncertainty regarding both the correct climate model and the appropriate time discount rate to use in intergenerational assessment of policy consequences. The analysis specifies a range of discount rates to express both empirical and normative uncertainty about the appropriate rate. The findings regarding climate policy are novel and informative. The MMR analysis points to use of a relatively low discount rate of 0.02 for climate policy. The MMR decision rule keeps the maximum future temperature increase below 2°C above the 1900-10 level for most of the parameter values used to weight costs and damages.

Data in Brief, 2017

Data on certainty equivalent discount factors and discount rates for stochastic interest rates in Australia are provided in this paper. The data has been used for the analysis of investments into climate adaptation projects in 'It's not now or never: Implications of investment timing and risk aversion on climate adaptation to extreme events' (Truong and Trück, 2016) [3] and can be used for other costbenefit analysis studies in Australia. The data is of particular interest for the discounting of projects that create monetary costs and benefits in the distant future.

2007

Time perspective – the tendency to foreshorten time units as we peer further into the future – implies hyperbolic discounting. We study implications of hyperbolic discounting for climate change policy, using a model in which the probability of a climate-induced catastrophe depends on the stock of greenhouse gasses (GHG). We characterize the set of Markov perfect equilibria of the intergenerational game in which each generation can either do nothing or stabilize atmospheric GHG concentration, and compare this set to a "restricted commitment" benchmark. We calculate the associated "constant equivalent discount rates" and the corresponding levels of expenditure to control climate change, and compare these results to discounting assumptions and policy recommendations in the Stern Review on Climate Change.

Discounting in the presence of catastrophic risk is a hotly debated issue, in particular with respect to climate change. Many scientists and laymen concerned with potentially catastrophic impacts feel that if an increase in the discount rate drastically increases the likelihood of catastrophic outcomes, this discredits economic cost-benefit calculations. This paper argues that this intuition is sound and that if cost-benefit calculations are done within a model that encompasses the type of catastrophic risk that these scientists worry about, the resulting stabilization target will only be slightly influenced by the discount rate. This is shown within a stylized model of a risk neutral decision maker facing a problem with a catastrophic threshold with unknown location.

… . Disponível em: http:// …, 2006

Monetary valuation of climate-change impacts, and the cost-benefit analysis of climate-change policy into which it feeds, has long been controversial. Writers in ecological economics have done much to illuminate its difficulties. For the purposes of this paper, the key difficulties of the cost-benefit approach are, first, discounting future costs and benefits at comparatively high rates, second, the often implicit assumption of perfect substitutability between natural capital and other forms of capital and, third, the treatment of uncertainty, much of which is very difficult to quantify in this case. On the other hand, alternative approaches to climate-change policy based on safe minimum standards are not without their weaknesses either. They are largely arbitrary and, as a result, arguably more politically unstable. Thus the in-principle need for cost-benefit analysis will not diminish.

Policy Research Working Papers, 1999

Uncertainty is an inherent phenomena in global warmning issues. First, there is considerable scientific uncertainty around the magnitude of global warming, and second, even if this problem was resolved, it remains difficult to measure in monetary tenns the benefits and the costs associated with the policies aimed at reducing global warming. Although uncertainty affects the policy-makers' decision to reduce (or not) global warming, such an influence is ignored in most existing studics. The aim of this paper is to explicitly incorporate the effect of uncertainty on the choice of global warming abatement policies. The approach developed in this paper is related to the emerging literature on investment under uncertainty, and in particular to the option-valuation approach. Our numerical applications will focus on Cline's (1992) analysis of global wanning, but our approach may be applied to a wide range of global warming analyses presented in the literature. We are able to obtain two kind of results. First, we assess whether it is optimal to implement a given strategy of limiting global wanning today or whether it should be postponed, and for how long. Second, we identify the optimal policy to be implemented today, for different levels of uncertainty around the costs and benefits of limiting global warming.

SSRN Electronic Journal, 2007

Low probability catastrophic climate change can have a significant influence on policy under hyperbolic discounting. We compare the set of Markov Perfect Equilibria (MPE) to the optimal policy under time-consistent commitment. For some initial levels of risk there are multiple MPE; these may involve either excessive or insufficient stabilization effort. These results imply that even if the free-rider problem amongst contemporaneous decision-makers were solved, there may remain a coordination problem amongst successive generations of decision-makers. A numerical example shows that under plausible conditions society should respond vigorously to the threat of climate change.

2016

… and Resource Economics, 2005

The last few years have witnessed important advances in our understanding of time preference and social discounting. In particular, several rationales for the use of time-varying social discount rates have emerged. These rationales range from the ad hoc to the formal, with some founded solely in economic theory while others reflect principles of intergenerational equity. While these advances are to be applauded, the practitioner is left with a confusing array of rationales and the sense that almost any discount rate can be justified. This paper draws together these different strands and provides a critical review of past and present contributions to this literature. In addition to this we highlight some of the problems with employing DDRs in the decision-making process, the most pressing of which may be time inconsistency. We clarify their practical implications, and potential pitfalls, of the more credible rationales and argue that some approaches popular in environmental economics literature are ill-conceived. Finally, we illustrate the impact of different approaches by examining global warming and nuclear power investment. This includes an application and extension of Newell and Pizer ['Discounting the benefits of climate change mitigation: how much do uncertain rates increase valuations?' Journal of Environmental Economics and Management 46 (2003) 52] to UK interest rate data.

I argue that the use of a social discount rate to assess the costs and benefits of policy responses to climate change is unhelpful and misleading. I consider two lines of justification for discounting, one ethical and the other economic, connected to the two terms of the standard formula for the discount rate. Concerning the former, I examine some arguments recently put forward by Joseph Heath and others for a "pure rate of time preference " and conclude that they fail to overcome standard ethical arguments for temporal neutrality. Concerning the latter, I consider whether the standard economic rationale for discounting, based on the diminishing marginal utility of consumption, is relevant to the specific costs and benefits at stake in climate policy. I argue that it is not, since the unusually long time horizons and nature of the costs and benefits in the climate context mean that a great many of the idealizing assumptions required by this economic rationale do not adequately approximate the underlying reality. The unifying theme of my objections is that all extant rationales for time discounting, both ethical and economic, justify it only as a proxy for normative concerns that have no intrinsic connection to the passage of time, and that in consequence, for any proposed application of a discount rate to ethical or public policy questions, it must be asked whether that approximation is useful to the case at hand. Where it is not, other means must be found to represent the concerns that motivate discounting, and in the concluding section I sketch such an alternative for the case of climate change.

2007

A constant social discount rate cannot reflect both a reasonable opportunity cost of public funds and an ethically defensible concern for generations in the distant future. We use a model of hyperbolic discounting that achieves both goals. We imbed this discounting model in a simple climate change model to calculate constant equivalent discount rates" and plausible levels of expenditure to control climate change. We compare these results to discounting assumptions and policy recommendations in the Stern Review on Climate Change.

2017

We review recent models of choices under uncertainty that have been proposed in the economic literature. The framework that we propose is general and may be applied in many different fields of environmental economics. To illustrate, we provide a simple application in the context of an optimal mitigation policy. Our objective is to offer guidance to policy makers who face uncertainty when designing climate policy.

RePEc: Research Papers in Economics, 1993