Working Paper: NBER ID: w18301
Authors: Lawrence H. Goulder; Roberton C. Williams III
Abstract: Nearly all discussions about the appropriate consumption discount rate for climate-change policy evaluation assume that a single discount rate concept applies. We argue that two distinct concepts and associated rates apply. We distinguish a social-welfare-equivalent discount rate appropriate for determining whether a given policy would augment social welfare (according to a postulated social welfare function) and a finance-equivalent discount rate suitable for determining whether the policy would offer a potential Pareto improvement. \n\nDistinguishing the two rates helps resolve arguments as to whether the choice of discount rate should be based on ethical considerations or empirical information (such as market interest rates), and about whether the discount rate should serve a prescriptive or descriptive role. Separating out the two rates also helps clarify disputes about the appropriate stringency of climate change policy.\n\nWe find that the structure of leading numerical optimization models used for climate policy analysis may have helped contribute to the blurring of the differences between the two rates. In addition, we indicate that uncertainty about underlying ethical parameters or market conditions implies that both rates should decline as the time-horizon increases.
Keywords: climate change; discount rate; policy evaluation; social welfare; Pareto improvement
JEL Codes: D61; D63; H43; Q54
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher discount rate (rf) (E43) | less aggressive climate policies (Q58) |
| lower discount rate (rsw) (E43) | more aggressive climate policies (Q58) |
| discount rate (E43) | policy recommendations (D78) |
| numerical optimization models (C61) | confusion surrounding discount rates (E43) |
| time horizon (C41) | uncertainty about ethical parameters and market conditions (D81) |