The Choice of Discount Rate for Climate Change Policy Evaluation

23 Pages Posted: 18 Aug 2012

See all articles by Lawrence H. Goulder

Lawrence H. Goulder

Stanford University - Department of Economics; National Bureau of Economic Research (NBER); Resources for the Future

Roberton C. Williams

University of Maryland - Department of Agricultural & Resource Economics; National Bureau of Economic Research (NBER); Resources for the Future

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Date Written: August 2012

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. Distinguishing 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.We 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.

Suggested Citation

Goulder, Lawrence H. and Williams, Roberton C., The Choice of Discount Rate for Climate Change Policy Evaluation (August 2012). NBER Working Paper No. w18301, Available at SSRN: https://ssrn.com/abstract=2131613

Lawrence H. Goulder (Contact Author)

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Roberton C. Williams

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