On the Underestimation of the Precautionary Effect in Discounting

21 Pages Posted: 4 Aug 2011

See all articles by Christian Gollier

Christian Gollier

University of Toulouse 1 - Industrial Economic Institute (IDEI); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: July 29, 2011

Abstract

Using the extended Ramsey rule, the socially efficient rate is the difference between a wealth effect and a precautionary effect of economic growth. This second effect is increasing in the degree of uncertainty affecting the future. In the literature, it is usually calibrated by estimating the historical volatility of the growth of GDP in a specific country. In this paper, I show that using cross-section data tends to magnify uncertainty, and to reduce the discount rate. Using a data set covering 190 countries over the period 1969-2010, I justify using a much smaller discount rate around 0.7% per year for time horizons exceeding 40 years.

Keywords: discount rate, prudence, climate change

JEL Classification: D900, Q510

Suggested Citation

Gollier, Christian, On the Underestimation of the Precautionary Effect in Discounting (July 29, 2011). CESifo Working Paper Series No. 3536. Available at SSRN: https://ssrn.com/abstract=1904761

Christian Gollier (Contact Author)

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

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CESifo (Center for Economic Studies and Ifo Institute) ( email )

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Germany

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