The Choice of Discount Rate for Climate Change Policy Evaluation
AbstractNearly all discussions about the appropriate consumption discount rate for climate change policy evaluation assume that a single discount rate concept applies. We argue that two distinct concepts and associated rates apply. We distinguish between a social-welfare-equivalent discount rate appropriate for determining whether a given policy would augment social welfare (according to a postulated social welfare function) and a finance-equivalent discount rate suitable for determining whether the policy would offer a potential Pareto improvement. Distinguishing between the two rates helps resolve arguments as to whether the choice of discount rate should be based on ethical considerations or empirical information (such as market interest rates), and whether the discount rate should serve a prescriptive or descriptive role. Separating out the two rates also helps clarify disputes about the appropriate stringency of climate change policy. We find that the structure of leading numerical optimization models used for climate policy analysis may have helped contribute to the blurring of the differences between the two rates. In addition, we indicate that uncertainty about underlying ethical parameters or market conditions implies that both rates should decline as the time horizon increases.
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Bibliographic InfoPaper provided by Resources For the Future in its series Discussion Papers with number dp-12-43.
Date of creation: 06 Sep 2012
Date of revision:
climate change; discounting; discount rate;
Other versions of this item:
- Lawrence H. Goulder & Roberton C. Williams, 2012. "The Choice Of Discount Rate For Climate Change Policy Evaluation," Climate Change Economics (CCE), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 1250024-1-1.
- Lawrence H. Goulder & Roberton C. Williams III, 2012. "The Choice of Discount Rate for Climate Change Policy Evaluation," NBER Working Papers 18301, National Bureau of Economic Research, Inc.
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
- D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
- H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
- Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-22 (All new papers)
- NEP-ENE-2012-09-22 (Energy Economics)
- NEP-ENV-2012-09-22 (Environmental Economics)
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- Rozenberg, Julie & Vogt-Schilb, Adrien & Hallegatte, Stephane, 2013. "How capital-based instruments facilitate the transition toward a low-carbon economy : a tradeoff between optimality and acceptability," Policy Research Working Paper Series 6609, The World Bank.
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"How Should Benefits and Costs Be Discounted in an Intergenerational Context?,"
dp-12-42, Resources For the Future.
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