How Should Benefits and Costs Be Discounted in an Intergenerational Context?
AbstractShould governments, in discounting the future benefits and costs of public projects, use a discount rate that declines over time? The argument for a declining discount rate is a simple one: if the discount rates that will be applied in the future are persistent, and if the analyst can assign probabilities to these discount rates, this will result in a declining schedule of certainty-equivalent discount rates. A growing empirical literature estimates models of long-term interest rates and uses them to forecast the declining discount rate schedule. I briefly review this literature, focusing on models for the United States. This literature has, however, been criticized for a lack of connection to the theory of project evaluation. In cost-benefit analysis, the net benefits of a project in year t (in consumption units) are to be discounted to the present at the rate at which society would trade consumption in year t for consumption in the present. With simplifying assumptions, this leads to the Ramsey discounting formula. The Ramsey formula results in a declining certainty-equivalent discount rate if the rate of growth in consumption is uncertain and if shocks to consumption are correlated over time. Using the extended Ramsey formula to estimate a numerical schedule of certainty-equivalent discount rates is, however, challenging.
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Bibliographic InfoPaper provided by Resources For the Future in its series Discussion Papers with number dp-12-42.
Date of creation: 12 Oct 2012
Date of revision:
discount rate; uncertainty; declining discount rate; cost-benefit analysis;
Other versions of this item:
- Richard S. J. Tol & Kenneth J. Arrow & Maureen L. Cropper & Christian Gollier & Ben Groom & Geoffrey M. Heal & Richard G. Newell & William D. Nordhaus & Robert S. Pindyck & William A. Pizer & Paul R. , 2013. "How Should Benefits and Costs Be Discounted in an Intergenerational Context?," Working Paper Series 5613, Department of Economics, University of Sussex.
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-03 (All new papers)
- NEP-ENE-2012-11-03 (Energy Economics)
- NEP-PPM-2012-11-03 (Project, Program & Portfolio Management)
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Discounting for future generations: the consensus?
by Economic Logician in Economic Logic on 2013-02-20 15:45:00
- How Should Benefits and Costs Be Discounted in an Intergenerational Context?
by David Stern in Stochastic Trend on 2013-02-05 04:44:00
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