Working Paper: NBER ID: w18157
Authors: Martin L. Weitzman
Abstract: The long term discount rate is critically dependent upon projections of future growth rates that are fuzzier in proportion to the remoteness of the time horizon. This paper models such increasing fuzziness as an evolving hidden-state stochastic process. The underlying trend growth rate is an unobservable random walk hidden by noisy transitory shocks and recoverable only as a probability distribution via Bayesian updating. A simple expression is derived for the time-declining Ramsey discount rate. The components of this hidden-state Ramsey discounting formula are then analyzed, followed by a few remarks about possible implications and applications.
Keywords: No keywords provided
JEL Codes: Q5; Q54
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Unobservable growth rates (X) (O40) | observed consumption growth (C) (E20) |
| observed consumption growth (C) (E20) | discount rate (R) (H43) |
| uncertain growth rates (O49) | declining discount rate over time (E43) |
| uncertainty about growth rate persists (D89) | discount rate will decline quadratically over time (E43) |
| fluctuations in growth rates (E32) | probability distribution of future growth outcomes (C46) |