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How Should Benefits and Costs Be Discounted in an Intergenerational Context?

  • Richard S. J. Tol

    ()

    (Department of Economics, University of Sussex, Brighton, United Kingdom
    Institute for Environmental Studies, Vrije Universiteit, Amsterdam, Netherlands
    Department of Spatial Economics, Vrije Universiteit, Amsterdam, Netherlands)

  • 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. Portney
  • Thomas Sterner
  • Martin L. Weitzman

In September 2011, the US Environmental Protection Agency asked 12 economists how the benefits and costs of regulations should be discounted for projects that affect future generations. This paper summarizes the views of the panel on three topics: the use of the Ramsey formula as an organizing principle for determining discount rates over long horizons, whether the discount rate should decline over time, and how intra- and intergenerational discounting practices can be made compatible. The panel members agree that the Ramsey formula provides a useful framework for thinking about intergenerational discounting. We also agree that theory provides compelling arguments for a declining certainty-equivalent discount rate. In the Ramsey formula, uncertainty about the future rate of growth in per capita consumption can lead to a declining consumption rate of discount, assuming that shocks to consumption are positively correlated. This uncertainty in future consumption growth rates may be estimated econometrically based on historic observations, or it can be derived from subjective uncertainty about the mean rate of growth in mean consumption or its volatility. Determining the remaining parameters of the Ramsey formula is, however, challenging.

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File URL: http://www.sussex.ac.uk/economics/documents/wps-56-2013.pdf
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Paper provided by Department of Economics, University of Sussex in its series Working Paper Series with number 5613.

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Date of creation: Jan 2013
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Handle: RePEc:sus:susewp:5613
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