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Yes, we should discount the far-distant future at its lowest possible rate: A resolution of the Weitzman-Gollier puzzle

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  • Freeman, Mark C.

Abstract

In this paper the author proves that the Expected Net Future Value (ENFV) criterion can lead a risk neutral social planner to reject projects that increase expected utility. By contrast, the Expected Net Present Value (ENPV) rule correctly identifies the economic value of the project. While the ENFV increases with uncertainty over future interest rates, the expected utility decreases because of the planner's desire to smooth consumption across time. This paper therefore shows that Weitzman (1998) is 'right' and that, within his economy, the far-distant future should be discounted at its lowest possible rate.

Suggested Citation

  • Freeman, Mark C., 2010. "Yes, we should discount the far-distant future at its lowest possible rate: A resolution of the Weitzman-Gollier puzzle," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 4, pages 1-21.
    • Handle: RePEc:zbw:ifweej:201013
    DOI: 10.5018/economics-ejournal.ja.2010-13
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    References listed on IDEAS

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    1. Christian Gollier & Phoebe Koundouri & Theologos Pantelidis, 2008. "Declining discount rates: Economic justifications and implications for long-run policy [‘Regime switches in interest rates’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 23(56), pages 758-795.
    2. Hepburn, Cameron & Groom, Ben, 2007. "Gamma discounting and expected net future value," Journal of Environmental Economics and Management, Elsevier, vol. 53(1), pages 99-109, January.
    3. Gollier, Christian, 2004. "Maximizing the expected net future value as an alternative strategy to gamma discounting," Finance Research Letters, Elsevier, vol. 1(2), pages 85-89, June.
    4. Gollier, Christian, 2010. "Expected net present value, expected net future value, and the Ramsey rule," Journal of Environmental Economics and Management, Elsevier, vol. 59(2), pages 142-148, March.
    5. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
    6. Phoebe Koundouri & Theologos Pantelidis & Ben Groom & Ekaterini Panopoulou, 2007. "Discounting the distant future: How much does model selection affect the certainty equivalent rate?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(3), pages 641-656.
    7. Gollier, Christian, 2009. "Should we Discount the Far-Distant Future at its Lowest Possible Rate?," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 3, pages 1-14.
    8. Eric Jacquier & Alex Kane & Alan J. Marcus, 2005. "Optimal Estimation of the Risk Premium for the Long Run and Asset Allocation: A Case of Compounded Estimation Risk," Journal of Financial Econometrics, Oxford University Press, vol. 3(1), pages 37-55.
    9. Daniel C. Indro & Wayne Y. Lee, 1997. "Biases in Arithmetic and Geometric Averages as Estimates of Long-Run Expected Returns and Risk Premia," Financial Management, Financial Management Association, vol. 26(4), Winter.
    10. Pazner, Elisha A & Razin, Assaf, 1975. "On Expected Value vs. Expected Future Value," Journal of Finance, American Finance Association, vol. 30(3), pages 875-877, June.
    11. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
    12. Newell, Richard G. & Pizer, William A., 2004. "Uncertain discount rates in climate policy analysis," Energy Policy, Elsevier, vol. 32(4), pages 519-529, March.
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    Cited by:

    1. Traeger, Christian P., 2012. "What's the Rate? Disentangling the Weitzman and the Gollier Effect," CUDARE Working Papers 121932, University of California, Berkeley, Department of Agricultural and Resource Economics.
    2. Gollier, Christian, 2016. "Gamma discounters are short-termist," Journal of Public Economics, Elsevier, vol. 142(C), pages 83-90.
    3. Traeger, Christian P., 2013. "Discounting under uncertainty: Disentangling the Weitzman and the Gollier effect," Journal of Environmental Economics and Management, Elsevier, vol. 66(3), pages 573-582.
    4. Freeman, Mark C. & Groom, Ben, 2016. "How certain are we about the certainty-equivalent longterm social discount rate?," LSE Research Online Documents on Economics 67258, London School of Economics and Political Science, LSE Library.
    5. Mark C. Freeman & Ben Groom, 2015. "Positively Gamma Discounting: Combining the Opinions of Experts on the Social Discount Rate," Economic Journal, Royal Economic Society, vol. 125(585), pages 1015-1024, June.
    6. Wolfgang Buchholz, 2014. "Discounting in an Uncertain World - Disentangling the Debate on the Weitzman-Gollier Puzzle," CESifo Working Paper Series 4967, CESifo.
    7. Freeman, Mark C. & Groom, Ben, 2016. "How certain are we about the certainty-equivalent long term social discount rate?," Journal of Environmental Economics and Management, Elsevier, vol. 79(C), pages 152-168.
    8. Traeger, Christian P., 2012. "What's the rate? Disentangling the Weitzman and the Gollier effect," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt88x3d1vw, Department of Agricultural & Resource Economics, UC Berkeley.

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    More about this item

    Keywords

    Discount rates; term structure; capital budgeting; interest rate uncertainty; environmental planning;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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