Editor's Choice Should Governments Use a Declining Discount Rate in Project Analysis?

Kenneth Arrow, Maureen Cropper, Christian Gollier (), Ben Groom, Geoffrey Heal, Richard Newell, William Nordhaus, Robert Pindyck, William Pizer, Paul R. Portney, Thomas Sterner, Richard Tol and Martin Weitzman

Review of Environmental Economics and Policy, 2014, vol. 8, issue 2, 145-163

Abstract: Should governments use a discount rate that declines over time when evaluating the future benefits and costs of public projects? The argument for using a declining discount rate (DDR) is simple: if the discount rates that will be applied in the future are uncertain but positively correlated, and if the analyst can assign probabilities to these discount rates, then the result will be a declining schedule of certainty-equivalent discount rates. There is a growing empirical literature that estimates models of long-term interest rates and uses them to forecast the DDR schedule. However, this literature has been criticized because it lacks a connection to the theory of project evaluation. In benefit-cost analysis, the net benefits of a project in year t (in consumption units) are discounted to the present at the rate at which society would trade consumption in year t for consumption in the present. With simplifying assumptions, this leads to the Ramsey discounting formula, which results in a declining certainty-equivalent discount rate if the rate of growth in consumption is uncertain and if shocks to consumption are correlated over time. We conclude that the arguments in favor of a DDR are compelling and thus merit serious consideration by regulatory agencies in the United States. (JEL: D61)

Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (88)

Downloads: (external link)
http://hdl.handle.net/10.1093/reep/reu008 (application/pdf)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:renvpo:v:8:y:2014:i:2:p:145-163.

Ordering information: This journal article can be ordered from
https://academic.oup.com/journals

Access Statistics for this article

Review of Environmental Economics and Policy is currently edited by Robert Stavins

More articles in Review of Environmental Economics and Policy from Association of Environmental and Resource Economists Oxford University Press, Great Clarendon Street, Oxford OX2 6DP, UK. Contact information at EDIRC.
Bibliographic data for series maintained by Oxford University Press ().