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Declining discount rates and the Fisher Effect: Inflated past, discounted future?

  • Mark C. Freeman
  • Ben Groom
  • Ekaterini Panopoulou
  • Theologos Pantelidis

Uncertain, yet persistent, real rates of return to capital underpin one argument for using a declining schedule of social discount rates. Yet persistency is only present in approximately the first three-quarters of the time-series of US Treasury bond yields used by Newell and Pizer [37] to estimate the term structure for the US Environmental Protection Agency. This coincides with the period in which the series re�ects nominal, rather than real, interest rates. To overcome this disconnect the "Fisher Effect" is estimated using a cointegrated model of inflation and nominal interest rate data. The real interest rate series is then simulated and the certainty equivalent discount rate calculated without the need for extensive data transformations, such as smoothing out negative real interest rates. An arguably more credible schedule of declining discount rates is then estimated. International guidelines on Cost-Benefit Analysis should be updated to reflect this methodological advance

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Paper provided by Grantham Research Institute on Climate Change and the Environment in its series GRI Working Papers with number 109.

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Date of creation: Apr 2013
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Handle: RePEc:lsg:lsgwps:wp109
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