Long term discounting in a hidden-state stochastic growth process
Name:
Martin Weitzman
Title, organisation:
Professor, Harvard University
E-mail/phone:
mweitzman@harvard.edu, 617-495-5133
Summary:
The evaluation of distant future events (like climate change) depends critically upon the choice of a long term discount rate,
which itself is critically dependent upon projections of future growth rates that are fuzzier in proportion to the remoteness of
the time horizon. I model such kind of increasingly uncertain growth scenario as an evolving hidden-state stochastic process
in which the underlying trend growth rate is an unobservable random walk hidden by noisy transitory shocks. I believe that
this kind of hidden-state formulation raises important questions about modeling future growth rates and sheds useful new light
on the sources of a time-declining future discount rate. One source of a time-declining future discount rate is that we are
uncertain about the present underlying trend growth rate, which effect would remain to be played out over time even if the
future trend growth rate were to remain still and do no further meandering. The other source of a declining discount rate is
that we are uncertain about the future trend growth rate, which effect would remain even if we knew exactly the present
underlying trend growth rate. The model is at a global level of abstraction with strong emphasis on attaining overall clarity
and understandability of results by relying on specifications having great analytical tractability. A simple basic expression is
derived for an extension of the Ramsey equation that features a time-declining discount rate. The components of this hiddenstate Ramsey discounting formula are then analyzed, followed by a few remarks about possible implications and
applications.
Biography:
Martin Weitzman is a professor of economics at Harvard University. He holds a PhD in economics from MIT. His current
research interests are environmental and natural resource economics, climate change, discounting, economics of catastrophes,
cost-benefit analysis, comparison of alternative instruments for controlling pollution, green accounting, economics of
biodiversity and role of uncertainty in environmental economics. Weitzman serves as a consultant to The World Bank,
Stanford Research Institute and International Monetary Fund, amongst others.
Weitzman, M. (2009) Risk-adjusted gamma discounting. Journal of Environmental Economics and Management 60 (2010) 1Suggested
readings:
13.
Gollier, C., and M.L. Weitzman, (2010), How Should the Distant Future be Discounted When Discount Rates are Uncertain?
Economic Letters, 107(3), 350-353.
Weitzman, M. (2001). Gamma Discounting. The American Economic Review. Pp. 260-271
Weitzman, M. (1998). Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate. Journal of
Environmental Economics and Management 36 (1998) 201-208.