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On the Underestimation of the Precautionary Effect in Discounting

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  • Christian Gollier

Abstract

Using the extended Ramsey rule, the socially efficient rate is the difference between a wealth effect and a precautionary effect of economic growth. This second effect is increasing in the degree of uncertainty affecting the future. In the literature, it is usually calibrated by estimating the historical volatility of the growth of GDP in a specific country. In this paper, I show that using cross-section data tends to magnify uncertainty, and to reduce the discount rate. Using a data set covering 190 countries over the period 1969-2010, I justify using a much smaller discount rate around 0.7% per year for time horizons exceeding 40 years.

Suggested Citation

  • Christian Gollier, 2011. "On the Underestimation of the Precautionary Effect in Discounting," CESifo Working Paper Series 3536, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_3536
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    File URL: http://www.cesifo-group.de/DocDL/cesifo1_wp3536.pdf
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    References listed on IDEAS

    as
    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December.
    3. Christian Gollier, 2008. "Discounting with fat-tailed economic growth," Journal of Risk and Uncertainty, Springer, vol. 37(2), pages 171-186, December.
    4. Shane Frederick & George Loewenstein & Ted O'Donoghue, 2002. "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 40(2), pages 351-401, June.
    5. Gollier, Christian & Weitzman, Martin L., 2010. "How should the distant future be discounted when discount rates are uncertain?," Economics Letters, Elsevier, vol. 107(3), pages 350-353, June.
    6. Gollier, Christian, 2002. "Time Horizon and the Discount Rate," Journal of Economic Theory, Elsevier, vol. 107(2), pages 463-473, December.
    7. repec:hrv:faseco:33373345 is not listed on IDEAS
    8. Saul Pleeter & John T. Warner, 2001. "The Personal Discount Rate: Evidence from Military Downsizing Programs," American Economic Review, American Economic Association, vol. 91(1), pages 33-53, March.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Hultkrantz, Lars & A. Krüger, Niclas & Mantalos, Panagiotis, 2014. "Risk-adjusted long-term social rates of discount for transportation infrastructure investment," Research in Transportation Economics, Elsevier, vol. 47(C), pages 70-81.

    More about this item

    Keywords

    discount rate; prudence; climate change;

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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