Monday, January 21, 2013

New Report on Intergenerational Discounting

An important new report by a panel of highly esteemed experts on cost-benefit analysis and discounting recommends declining discount rates for long-run environmental (and other) policies, where the future rate of growth in mean consumption is subjectively uncertain. However, they do not recommend a specific schedule of declining discount rates either because the EPA did not ask them to tackle the politically hoary (and ultimately subjective) task of estimating the values that would comprise the Ramsey equation (including the pure rate of time preference and the coefficient of relative risk aversion, plus a process for generating the certainty equivalent of future growth in the mean rate of consumption) or because they could not reach consensus on those values.

The title of the report is, "How Should Benefits and Costs Be Discounted in an Intergenerational Context? The Views of an Expert Panel." The authors are Kenneth Arrow, Maureen Cropper, Christian Gollier, Ben Groom, Geoffrey Heal, Richard Newell, William Nordhaus, Robert Pindyck, William Pizer, Paul Portney, Thomas Sterner, Richard Tol, and Martin Weitzman. Here is the abstract:
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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