Discounting and the Representative Median Agent

Johannes Emmerling

No 271, GRI Working Papers from Grantham Research Institute on Climate Change and the Environment

Abstract: Under assumptions typically used in applied work, we derive an `inequality- adjusted' social discount rate (SDR) that reflects the dynamics of income inequality. The inequality-adjustment alters the wealth effect in the standard Ramsey rule to refect the distributional consequences of consumption growth in the presence of inequality aversion. The adjustment is proportional to the difference between the growth of the mean and median income, where the constant of proportionality is the Atkinson index of inequality aversion. A special case leads to agents with median incomes being representative agents. With a degree of inequality aversion of 1 (1.5, 2), the UK and U.S. SDRs would be approximately 0.25% (0.5%, 1%) lower than the standard Ramsey rule, refecting the slower growth of the median incomes compared with income per capita, and hence rising inequality over the past two decades. Where inequality is on the decline, higher SDRs are recommended. Our inequality- adjusted SDR accounts for the welfare effects of secular changes in inequality in the appraisal of public projects.

Date: 2017-07
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Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Discounting and the representative median agent (2017)
Working Paper: Discounting and the representative median agent (2017)
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