The Choice of Discount Rate for Climate Change Policy Evaluation

Resources for the Future Discussion Paper No. 12-43

25 Pages Posted: 12 Sep 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

Multiple version iconThere are 2 versions of this paper

Date Written: September 6, 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 between 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 between 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 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.

Keywords: climate change, discounting, discount rate

JEL Classification: D61, D63, H43, Q54

Suggested Citation

Goulder, Lawrence H. and Williams, Roberton C., The Choice of Discount Rate for Climate Change Policy Evaluation (September 6, 2012). Resources for the Future Discussion Paper No. 12-43, Available at SSRN: https://ssrn.com/abstract=2145578 or http://dx.doi.org/10.2139/ssrn.2145578

Lawrence H. Goulder

Stanford University - Department of Economics ( email )

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Roberton C. Williams (Contact Author)

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