Wednesday, December 16, 2009

Gollier & Weitzman on Discounting under Uncertainty

The paper is here. Here is the abstract:

It is not immediately clear how to discount distant-future events, like climate change, when the distant-future discount rate itself is uncertain. The so-called "Weitzman-Gollier puzzle" is the fact that two seemingly symmetric and equally plausible ways of dealing with uncertain future discount rates appear to give diametrically opposed results with the opposite policy implications. We explain how the "Weitzman-Gollier puzzle" is resolved. When agents optimize their consumption plans and probabilities are adjusted for risk, the two approaches are identical. What we would wish the reader to take away from this paper is the bottom-line message that the appropriate long run discount rate declines over time toward its lowest possible value.
 I don't have the expertise to independently assess the paper's mathematical model, but the findings would support a change in the economic analysis of long-term federal environmental policies toward the use of discount rates that decline over time toward zero. Such a change would be consistent with policy in the UK, where HM Treasury already uses a schedule of declining discount rates. It is also consistent with the aggregate view of thousands of US economists, as reported by Weitzman in a 2001 paper (here).

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