1932

Abstract

The choice of the rate at which one should discount the long-term benefits of mitigating climate change is highly controversial. Both the level and the slope of the term structure of discount rates have been discussed intensively in relation to the determination of the social cost of carbon. Although some of the parameters of the problem are ethical and outside the scope of economic analysis, we claim that there are converging and convincing arguments in favor of using an annual real risk-free discount rate going from approximately 4% to approximately 1% for maturities going from zero to infinity. Investing in climate mitigation yields highly uncertain future benefits. Such uncertainty should also be taken into account in the selection of the discount rate, although the appropriate approach is highly controversial.

Loading

Article metrics loading...

/content/journals/10.1146/annurev-resource-100913-012516
2014-10-05
2024-03-29
Loading full text...

Full text loading...

/deliver/fulltext/resource/6/1/annurev-resource-100913-012516.html?itemId=/content/journals/10.1146/annurev-resource-100913-012516&mimeType=html&fmt=ahah

Literature Cited

  1. Arrow KJ. 1999. Discounting, morality, and gaming. In Discounting and Intergenerational Equity, ed. PR Portney, JP Weyant, pp. 13–21.Washington, DC: Resour. Future
  2. Arrow KJ. 2007. Global climate change: a challenge to policy. Economists’ Voice, June
  3. Arrow K, Cropper M, Gollier C, Groom B, Heal G et al. 2013. Determining benefits and costs for future generations. Science 341:349–50 [Google Scholar]
  4. Arrow KJ, Cropper ML, Gollier C, Groom B, Heal GM et al. 2014. Should governments use a declining discount rate in project analysis?. Rev. Environ. Econ. Policy 8:145–63 [Google Scholar]
  5. Arrow KJ, Lind RC. 1970. Uncertainty and the evaluation of public investment decision. Am. Econ. Rev. 60:364–78 [Google Scholar]
  6. Barro RJ. 2006. Rare disasters and asset markets in the twentieth century. Q. J. Econ. 121:823–66 [Google Scholar]
  7. Barro RJ. 2009. Rare disasters, asset prices, and welfare costs. Am. Econ. Rev. 99:243–64 [Google Scholar]
  8. Bockstael N, Freeman AM III, Kopp RJ, Portney PR, Smith VK. 2000. On measuring economic values for nature. Environ. Sci. Technol. 34:1384–89 [Google Scholar]
  9. Breeden D. 1979. An intertemporal asset pricing model with stochastic consumption and investment opportunities. J. Financ. Econ. 7:265–96 [Google Scholar]
  10. Buchholz W, Schumacher J. 2008. Discounting the long distant future: simple explanation for the Weitzman-Gollier-puzzle. Work. Pap. 2,357, CESifo
  11. Cline WR. 1992. The Economics of Global Warming Washington, DC: Inst. Int. Econ.
  12. Costanza R, d’Arge R, de Groot R, Farber S, Grasso M et al. 1997. The value of the world's ecosystem services and natural capital. Nature 387:253–60 [Google Scholar]
  13. Dasgupta P. 2007. Comments on the Stern Review’s economics of climate change. Natl. Inst. Econ. Rev. 199:14–7 [Google Scholar]
  14. Drèze JH, Modigliani F. 1972. Consumption decisions under uncertainty. J. Econ. Theory 5:308–35 [Google Scholar]
  15. Eeckhoudt L, Rey B, Schlesinger H. 2007. A good sign for multivariate risk taking. Manag. Sci. 53:117–24 [Google Scholar]
  16. Epstein LG, Zin S. 1991. Substitution, risk aversion and the temporal behavior of consumption and asset returns: an empirical framework. J. Polit. Econ. 99:263–86 [Google Scholar]
  17. Freeman MC. 2010. Yes, we should discount the far-distant future at its lowest possible rate: a resolution of the Weitzman-Gollier puzzle. Economics 4:2010–13 [Google Scholar]
  18. Freeman MC, Groom B. 2010. Gamma discounting the combination of forecasts. Unpubl. Pap
  19. Froot KA. 1989. New hope for the expectations hypothesis of the term structure of interest rates. J. Finance 44:283–305 [Google Scholar]
  20. Gollier C. 2002. Discounting an uncertain future. J. Public Econ. 85:149–66 [Google Scholar]
  21. Gollier C. 2004. Maximizing the expected net future value as an alternative strategy to gamma discounting. Finance Res. Lett. 1:85–89 [Google Scholar]
  22. Gollier C. 2008. Discounting with fat-tailed economic growth. J. Risk Uncertain. 37:171–86 [Google Scholar]
  23. Gollier C. 2009. Should we discount the far-distant future at its lowest possible rate?. Economics 3:2009–25 [Google Scholar]
  24. Gollier C. 2010. Expected net present value, expected net future value, and the Ramsey rule. J. Environ. Econ. Manag. 59:142–48 [Google Scholar]
  25. Gollier C. 2011. Le calcul du risque dans les investissements publics. Rapp. Doc. 36, Cent. Anal. Stratég., Doc. Fr., Paris
  26. Gollier C. 2012. Pricing the Planet’s Future: The Economics of Discounting in an Uncertain World Princeton, NJ: Princeton Univ. Press
  27. Gollier C. 2013. Evaluation of long-dated investments under uncertain growth trend, volatility and catastrophes. Work. Pap., Toulouse Sch. Econ
  28. Gollier C, Weitzman ML. 2010. How should the distant future be discounted when discount rates are uncertain?. Econ. Lett. 107:3350–53 [Google Scholar]
  29. Gordon RJ. 2012. Is US economic growth over? Faltering innovation confronts the six headwinds. NBER Work. Pap. 18315
  30. Gravelle H, Smith D. 2001. Discounting for health effects in cost-benefit and cost-effectiveness analysis. Health Econ. 10:587–99 [Google Scholar]
  31. Groom B, Koundouri P, Panopoulou E, Pantelidis T. 2007. Discounting the distant future: How much does model selection affect the certainty equivalent rate?. J. Appl. Econ. 22:3641–56 [Google Scholar]
  32. Guesnerie R. 2004. Calcul économique et développement durable. Rev. Econ. 55:363–82 [Google Scholar]
  33. Hammitt JK. 1997. Stratospheric-ozone depletion. Economic Analyses at EPA: Assessing Regulatory Impact Morgenstern RD. 131–69 Washington, DC: Resour. Future [Google Scholar]
  34. Hammitt JK. 2012. Discounting health and cost-effectiveness analysis: a response to Nord. Health Econ. 21:878–82 [Google Scholar]
  35. Hammitt JK. 2013. Admissible utility functions for health, longevity, and wealth: integrating monetary and life-year measures. J. Risk Uncertain. 47:311–25 [Google Scholar]
  36. Hansen L, Singleton K. 1983. Stochastic consumption, risk aversion and the temporal behavior of asset returns. J. Polit. Econ. 91:249–65 [Google Scholar]
  37. Hepburn C, Groom B. 2007. Gamma discounting and expected net future value. J. Environ. Econ. Manag. 53:99–109 [Google Scholar]
  38. HM Treasury 2003. [updated July 2011]. The Green Book—Appraisal and Evaluation in Central Government. London: HM Treasury
  39. Hoel M, Sterner T. 2007. Discounting and relative prices. Clim. Change 84:265–80 [Google Scholar]
  40. Horowitz J, Lange A. 2009. What’s wrong with infinity—a note on Weitzman’s dismal theorem. Unpubl. Pap., Dep. Agric. Resour. Econ., Univ. Md. http://faculty.arec.umd.edu/jhorowitz/weitzman_final.pdf
  41. IPCC 1995. Second assessment report. Rep., IPCC
  42. Ju N, Miao J. 2012. Ambiguity, learning and asset returns. Econometrica 80:559–91 [Google Scholar]
  43. Karp L. 2009. Sacrifice, discounting, and climate policy: five questions. Work. Pap. 2,761, CESifo. http://are.berkeley.edu/∼karp/FiveQuestionsSubmit.pdf
  44. Keynes JM. 1930. Treatise on Money London: Macmillan
  45. Kimball M. 1990. Precautionary saving in the small and in the large. Econometrica 58:153–73 [Google Scholar]
  46. Kling CL, Phaneuf DJ, Zhao J. 2012. From Exxon to BP: Has some number become better than no number?. J. Econ. Perspect. 26:3–26 [Google Scholar]
  47. Lebègue D. 2005. Révision du taux d’actualisation des investissements publics Paris: Commis. Gén. Plan
  48. Leland HE. 1968. Saving and uncertainty: the precautionary demand for saving. Q. J. Econ. 82:465–73 [Google Scholar]
  49. Lucas R. 1978. Asset prices in an exchange economy. Econometrica 46:1429–46 [Google Scholar]
  50. Macaulay FR. 1938. Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond Yields, and Stock Prices in the United States Since 1856 New York: NBER
  51. Mehra R, Prescott E. 1985. The equity premium: a puzzle. J. Monet. Econ. 10:335–39 [Google Scholar]
  52. Malinvaud E. 1953. Capital accumulation and efficient allocation of resources. Econometrica 21:233–68 [Google Scholar]
  53. Millner A. 2013. On welfare frameworks and catastrophic climate risks. J. Environ. Econ. Manag. 65:2310–25 [Google Scholar]
  54. Moog M, Bösch M. 2013. Interest rates in the German forest valuation literature of the early nineteenth century. For. Policy Econ. 30:1–5 [Google Scholar]
  55. Murphy KM, Topel RH. 2006. The value of health and longevity. J. Polit. Econ. 114:871–904 [Google Scholar]
  56. Murphy KM, Topel RH. 2013. Some basic economics of national security. Am. Econ. Rev. 103:3508–11 [Google Scholar]
  57. Newell R, Pizer WA. 2003. Discounting the distant future: How much do uncertain rates increase valuations?. J. Environ. Econ. Manag. 46:152–71 [Google Scholar]
  58. Newell RG, Pizer WA. 2004. Uncertain discount rates in climate policy analysis. Energy Policy 32:4519–29 [Google Scholar]
  59. Nordhaus WD. 1997. Do real output and real wage measures capture reality? The history of light suggests not. The Economics of New Goods Gordon RJ, Bresnahan TF. 29–66 Chicago: Univ. Chicago Press for NBER [Google Scholar]
  60. Nordhaus WD. 2003. The health of nations: the contribution of improved health to living standards. Measuring the Gains from Medical Research: An Economic Approach Murphy KM, Topel RH. 9–40 Chicago: Univ. Chicago Press [Google Scholar]
  61. Nordhaus WD. 2008. A Question of Balance: Weighing the Options on Global Warming Policies New Haven, CT: Yale Univ. Press
  62. Nordhaus WD. 2011. Estimates of the social cost of carbon: background and results from RICE-2011 model. NBER Work. Pap. 17540. http://www.nber.org/papers/w17540
  63. Norwegian Ministry of Finance 2012. Cost-benefit analysis. Off. Nor. Rep. NOU 2012:16, Nor. Gov
  64. Office of Management and Budget (OMB) 2003. Circular No. A-4, “Regulatory Analysis.” Washington, DC: Exec. Off. Pres
  65. Pazner EA, Razin A. 1975. On expected present value vs. expected future value. J. Finance 30:875–77 [Google Scholar]
  66. Pearce D, Ulph D. 1995. A social discount rate for the United Kingdom. CSERGE Work. Pap. 95-01, Sch. Environ. Stud., Univ. East Anglia
  67. Pindyck RS. 2013. Climate change policy: What do the models tell us?. J. Econ. Lit. 51:860–72 [Google Scholar]
  68. Ramsey FP. 1928. A mathematical theory of saving. Econ. J. 38:152543–59 [Google Scholar]
  69. Rubinstein M. 1976. The valuation of uncertain income streams and the pricing of options. Bell J. Econ. 7:2407–25 [Google Scholar]
  70. Sandsmark M, Vennemo H. 2007. A portfolio approach to climate investments: CAPM and endogenous risk. Environ. Resour. Econ. 37:681–95 [Google Scholar]
  71. Solow RM. 1956. A contribution to the theory of economic growth. Q. J. Econ. 70:165–94 [Google Scholar]
  72. Solow RM. 1974. Richard T. Ely Lecture: The economics of resources or the resources of economics. Am. Econ. Rev. 64:1–14 [Google Scholar]
  73. Stern N. 2007. The Economics of Climate Change: The Stern Review Cambridge, UK: Cambridge Univ. Press
  74. Stern NH. 1977. Welfare weights and the elasticity of the marginal valuation of income. In Proceedings of the AUTE Edinburgh Meeting of April 1976, ed. M Artis, R Nobay, Chapter 8. Oxford, UK: Blackwell
  75. Traeger C. 2013. Discounting under uncertainty: disentangling the Weitzman and the Gollier effect. J. Environ. Econ. Manag. 66:3573–82 [Google Scholar]
  76. Weil P. 1989. The equity premium puzzle and the risk-free rate puzzle. J. Monet. Econ. 24:401–21 [Google Scholar]
  77. Weitzman ML. 1998. Why the far-distant future should be discounted at its lowest possible rate. J. Environ. Econ. Manag. 36:3201–8 [Google Scholar]
  78. Weitzman ML. 2001. Gamma discounting. Am. Econ. Rev. 91:260–71 [Google Scholar]
  79. Weitzman ML. 2007a. A review of The Stern Review on the Economics of Climate Change. J. Econ. Lit. 45:703–24 [Google Scholar]
  80. Weitzman ML. 2007b. Subjective expectations and asset-return puzzle. Am. Econ. Rev. 97:1102–30 [Google Scholar]
  81. Weitzman ML. 2009. On modeling and interpreting the economics of catastrophic climate change. Rev. Econ. Stat. 91:1–19 [Google Scholar]
  82. Weitzman ML. 2010. Risk-adjusted gamma discounting. J. Environ. Econ. Manag. 60:1–13 [Google Scholar]
  83. Weitzman ML. 2012. Rare disasters, tail-hedged investments and risk-adjusted discount rates. NBER Work. Pap. 18496
  84. Weitzman ML. 2013. Can negotiating a uniform carbon price help to internalize the global warming externality? NBER Work. Pap. 19644
/content/journals/10.1146/annurev-resource-100913-012516
Loading
/content/journals/10.1146/annurev-resource-100913-012516
Loading

Data & Media loading...

  • Article Type: Review Article
This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error