Uncertain discount rates in climate policy analysis
Consequences in the distant future-such as those from climate change-have little value today when discounted using conventional rates. This result contradicts our "gut feeling" about such problems and often leads to ad hoc application of lower rates for valuations over longer horizons-a step facilitated by confusion and disagreement over the correct rate even over short horizons. We review the theory and intuition behind the choice of discount rates now and, importantly, the impact of likely variation in rates in the future. Correlated changes in future rates imply that the distant future should be discounted at much lower rates than suggested by the current rate, thereby raising the value of future consequences-regardless of opinions concerning the current rate. Using historic data to quantity the likely changes and correlation in changes in future rates, we find that future valuations rise by a factor of many thousands at horizons of 300 years or more, almost doubling the expected present value of climate mitigation benefits relative to constant 4% discounting. Ironically, uncertainty about future rates reduces the ratio of valuations based on alternate choices of the current rate. © 2003 Elsevier Ltd. All rights reserved.
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