20.05.2012 updated
The economics of long term discounting
Name:
Christian Gollier
Title, organisation:
Professor, University of Toulouse and LERNA
E-mail/phone:
christian.gollier@tse-fr.eu, +33 (0)5 61 12 86 30
Summary:
The discount rate is a key parameter in economics because it determines how our societies value their future. Its selection
should be governed by the following set of principles:
1.
Only those projects that raise the undiscounted sum of future collective utility should have a positive NPV.
2.
The driving force to discounting is the collective aversion to inequalities. I propose to set it to 2: Doubling
consumption divides marginal utility by 4.
3.
Following the Ramsey rule, safe real cash flows maturing within few years should be discounted at a rate that is 2
times the real growth rate of the economy.
4.
Because of large uncertainties about the evolution of our economies in the distant future, the term structure of real
discount rates should be decreasing. Assuming an expected growth rate of the economy around 2% per year, the
real safe discount rate should converge to 1.5% for distant maturities.
5.
Biography:
Suggested
readings:
Uncertain projects should be evaluated using these rates to discount the certainty equivalents of their cash flows.
Christian Gollier holds a Ph.D. in economics and a M.Sc. in Applied Mathematics from the University of Louvain. He is
currently Director of the Toulouse School of Economics (TSE), one of the best European departments of economics. Prior to
TSE, he held positions at the University of California at San Diego (post.doc. in 1988-89), and at HEC Paris (assistant then
associate professor, 1989-1994). He holds an advanced grant of the ERC entitled "Evaluation and management of collective
long-term risks". He is recognized as one of the best international specialists of the economics of climate change.
Gollier, C., (2008), Discounting with fat-tailed economic growth, Journal of Risk and Uncertainty, 37, 171-186.
http://idei.fr/doc/wp/2008/discount.pdf
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.
http://www.tse-fr.eu/images/doc/wp/fit/wp_fit_107_2009.pdf
Gollier, C., (2011), On the underestimation of the precautionary effect in discounting, Geneva Risk and Insurance Review 36,
95-111.
http://www.cesifo-group.de/portal/pls/portal/docs/1/1208086.PDF
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.
Social discounting under uncertainty: A cross country comparison
Name:
Cameron Hepburn
Title, organisation:
Dr, London School of Economics and Oxford University
E-mail/phone:
c.j.hepburn@lse.ac.uk,+44 207 106 1229
Summary:
My presentation will be practical and policy-focussed. I will review how uncertainty has been (and could be) incorporated into
social discounting by various national governments. I will consider this in the wider context of the analytical apparatus used
to support good policy decisions by government. The presentation will cover (i) a reminder of the practical role of CBA in
government decision-making; (ii) the conceptual basis for social discounting; (iii) the use of social discounting in government
decisions; (iv) a snapshot of practices across OECD countries, including attempts to incorporate uncertainty; (v) discounting
in the Stern Review and its impact on the UK government; (vi) discounting in the developing country context.
Biography:
Dr Cameron Hepburn is an economist specialising in environmental and public policy. He holds Fellowships at the LSE and
Oxford University. He was educated at Melbourne University in Law and Chemical Engineering, and earned his doctorate in
economics from Oxford (as a Rhodes Scholar).
He is actively involved in public policy as a member of the DECC Secretary of State's Economics Advisory Group, the
DEFRA Academic Panel and as a founder of Vivid Economics. He contributed two background research papers to the Stern
Review on the Economics of Climate Change.
Suggested
readings:
Hepburn, C. (2007) Use of Discount Rates in the Estimation of the Costs of Inaction with Respect to Selected Environmental
Concerns, OECD Environment Directorate, ENV/EPOC/WPNEP(2006)13/FINAL.
Hepburn, C., Koundouri, P., Panopoulou, E., Pantelidis, T. (2009) Social discounting under uncertainty: a cross country
comparison. Journal of Environmental Economics and Management 57, 140-150.
http://www.sciencedirect.com/science/article/pii/S0095069608000703
Stern, N., (2007), The Economics of Climate Change: The Stern Review. Cambridge University Press
The long term equilibrium interest rate and risk premiums under uncertainty
Name:
Knut K. Aase
Title, organisation:
Professor, Norwegian School of Economics (NHH)
E-mail/phone:
Knut.Aase@nhh.no, +47 55 95 92 49
Summary:
Both the equilibrium interest rate and the equity premium as well as risk premiums of risky investments are all important
quantities in cost-benefit analyses. In the light of the current (2008-) financial crisis, it is of interest to study models that
connect the financial sector with the real economy. The effects of climate change have, on the other hand, been the subject of
extensive discussions, for example in connection with the Stern report. The paper addresses both these issues. In particular we
investigate what is needed to have long-term interests sufficiently low. Our model allows us to tell what happens to risk
premiums in turbulent times, consistent with observations. We extend the pure exchange model to a production economy,
where we obtain a fairly low long-term equilibrium interest rate. The effects of shocks on the discount factor are investigated.
We end by a discussion of risk adjustments of the discount rate. For projects aimed at insuring future consumption, the
interest rate is smaller than the risk free rate. Mitigation can have the characteristics of such projects.
KEYWORDS: dynamic equilibrium; the Lucas model; term structure; CIR; pure exchange; production economy; equity
premium puzzle; risk free rate puzzle; climate models; Stern Review.
JEL-Code: G, D.
Biography:
Knut K. Aase is Professor of Economics at the Norwegian School of Economics (NHH). Educated at the University of Bergen
and the University of California, Berkeley. His area of specialization is (a) Economics of Uncertainty, (b) Asset Pricing
Theory, (c) Insurance, (d) Probabilistic models.
Suggested
readings:
The paper is a response to the conclusions/discussion related to the Stern Report, and it is sufficient to have knowledge about
this report in order to understand what I do. I base my analysis on standard concepts of risk premia, and show how some of
Stern's conclusion can be derived quite naturally, without making unrealistic assumptions about certain parameters in the
"standard model".
Investment Policy for Time-Inconsistent Discounters
Name:
Bård Harstad
Title, organisation:
Professor, University of Oslo
E-mail/phone:
Summary:
baardnh@econ.uio.no, +47 22 85 60 52
Abstract:
There is plenty of empirical evidence that people have time-inconsistent preferences: when comparing utilities in period t and
t+1, the discount factors tend to grow in t. This implies that politicians, as well as voters, prefer to invest, save, or consume in
a sustainable way, tomorrow, but not today. This paper derives the implications for public investment policies, investmenttaxes/subsidies, and the socially optimal discount factor.
Biography:
Bård Harstad is professor of economics at the University of Oslo (UIO). He holds a PhD from the Stockholm University
(IIES). His academic interests are political economics, public economics, contract theory and environmental economics. Prior
to UIO he held positions at the National Bureau of Economic research, Kellogg school of Management and Norwegian
Institute of international affairs, amongst others.
Suggested
readings:
3 related papers:
Laibson, David. 1997. "Golden Eggs and Hyperbolic Discounting."
Quarterly Journal of Economics 112(2): 443-477.
http://qje.oxfordjournals.org/content/112/2/443.abstract
Temptation and Taxation (Per Krusell, Burhanettin Kuruscu, Anthony Smith), Econometrica, 2010.
http://www.econ.yale.edu/smith/ecta8611.pdf
"Consumption-Savings Decisions with Quasi-Geometric Discounting"(Per Krusell and Anthony Smith). Econometrica, 71
(2003).
http://people.su.se/~pkrus/ref_pub/Consumption-savings.pdf
The background for the current Norwegian guidelines for discount rates for public projects
Name:
Geir Aavitsland
Title, organisation:
Director General, Ministry of Finance
E-mail/phone:
Geir.Avitsland@fin.dep.no, +47 22 24 40 72
Summary:
The presentation gives some background information for the Norwegian guidelines for public discount rates. It shows how a
framework based on estimation of parameters along an optimal consumption path has been replaced by a more market based
approach.
Biography:
Presently, I am director general in the Financial Markets Department in the Ministry of Finance. I have also worked in the Tax
Policy Department and the Budged Department in the MoF, and in the Office of the Prime Minister.
Suggested
readings:
The long term discount rate: Some comments from a practical point of view
Name:
Thore Johnsen
Title, organisation:
Professor, Norwegian School of Economics (NHH) , Norway
E-mail/phone:
Thore.Johnsen@nhh.no, + 47 55 95 92 91
Summary:
The presentation will discuss major issues in the practical implementation of models of cost of capital and discounting in long
public projects. The long horizon problem will be central, but the presentation will also discuss more general the measurement
and market calibration of risk adjustment in public projects. This will also include the choice between adjusting the project’s
net benefits and its discount rate.
Biography:
Thore Johnsen is a professor of Economics at the Norwegian School of Management (NHH). He holds a PhD from Carnegie
Mellon University. His teaching area is finance, and his research areas are valuation, risk management and energy markets.
Suggested
readings:
Discounting and intergenerational equity
Name:
Geir Asheim
Title, organisation:
Professor, University of Oslo
E-mail/phone:
g.b.asheim@econ.uio.no, + 47 22 85 54 98
Summary:
Is social discounting compatible with treating generations equally? Rank-discounted utilitarianism (RDU) treats generations
equally, by discounting utilities according to rank and not according to time.
Discounting becomes a mere expression of intergenerational inequality aversion. RDU is behaviourally indistinguishable from
time-discounted utilitarianism when well-being is correlated with time. In this case, future's higher wellbeing is discounted for
two reasons: (i) at a higher level, its wellbeing contributes less to utility, and (ii) being better off, its utility is assigned less
weight. However, RDU leads to different conclusions if climate change undermines future wellbeing.
Application of RDU for evaluating climate policies requires extensions to intratemporal inequality, variable population and
uncertainty, and I indicate how this can be done. I conclude by discussing the relevance of RDU for single-country decision
making.
Biography:
Geir Asheim is professor of economics at the department of economics, University of Oslo. He holds a doctor of philosophy
degree in economics at the university of California, Santa Barbara. He is/has been a visiting scholar or professor at l`Institut
d`etudes avancees (Paris), University of California, Cornell University, Stanford, Harvard, amongst others. His academic
interests are game theory, intergenerational justice, green national accounting, amongst others.
Suggested
readings:
Asheim, G.B. (2012) Discounting while treating generations equally. In Climate Change and Common Sense: Essays in
Honour of Tom Schelling (R.W.Hahn, A. Ulph, Eds.) Oxford UP.
Asheim, G.B., Mitra, T. (2010), Sustainability and discounted utilitarianism in models of economic growth, Mathematical
Social Sciences 59, 148–169;
http://folk.uio.no/gasheim/AM-MSS10.pdf
Asheim, G.B., Mitra, T., Tungodden, B. (2012), Sustainable recursive social welfare functions, Economic Theory 49, 267–
292;
Dietz, S., Asheim, G.B. (2012), Climate policy under sustainable discounted utilitarianism, Journal of Environmental
Economics and Management 63, 321–335
Zuber, S., Asheim, G.B. (forthcoming), Justifying social discounting: the rank-discounted utilitarian approach, Journal of
Economic Theory.
Gamma discounting
Name:
Title, organisation:
E-mail/phone:
Summary:
Ben Groom
Senior Lecturer in Economics, University of London
bg3@soas.ac.uk, + 44 (0) 207 898 4730
The presentation will focus on how to operationalise some of the theories of declining discount rates and obtain an empirical
schedule of discount rates. The presentation will discuss the pros and cons of the various empirical methods, and the impact on policy
of the different empirical approaches. The social cost of carbon will be used as a case study.
The theoretical basis to the presentation will be Weitzman (1998, 2001), and related studies advocating the Expected Net Present
Value approach (Cox Ingersoll and Ross 1981, Freeman 2010). Two empirical approaches will be discussed. First, the use of time
series data in interest rates, second, the role of expert opinion.
Methods using time series data in the context of social discounting began with Newell and Pizer (2003) and were extended by Groom
et al (2007), who considered the importance of time series model selection, and Hepburn et al (2009), who considered cross country
analysis. Recent work in progress by Groom et al (2012), who address data issues such as inflation, will also be presented.
Methods using expert opinion were pioneered by Weitzman’s (2001) Gamma Discounting paper. Freeman and Groom (2012) argue
that Weitzman’s approach can be interpreted as normative. Drawing on the literature on combining forecasts (e.g. Winckler 1981),
Freeman and Groom (2012) provide a ‘positive’ approach to Gamma Discounting, and show the choice of approach to discounting
(positive or normative) determines how one should combine expert opinion and derive the schedule of declining discount rates. The
normative – positive distinction is shown to be key once again, with strong effects on the estimates of the social cost of carbon.
Biography:
Dr Ben Groom is a senior lecturer in economics, department of economics, School of Oriental and African Studies, University of
London. He holds a PhD in economics from University College London.
Prior to the University of London, he held positions at the Asian Development Bank (ADB) and WWF Pakistan. His academic
interests are applied micro-econometrics, environmental and resource economics and development economics.
Suggested
readings:
Cox, J. C., Ingersoll, J. E. & Ross, S. A. (1981). A re-examination of traditional hypotheses about the term structure of interest rates,
Journal of Finance 36, 769-799.
Groom, B., Koundouri, P., Panipoulou, K., and T., Pantelides (2007), Discounting the distant future: How much does model selection
affect the certainty equivalent rate? Journal of Applied Econometrics, 22, 641-656.
Mark C. Freeman (2010). Yes, We Should Discount the Far-Distant Future at Its Lowest Possible Rate: A Resolution of the
Weitzman–Gollier Puzzle. Economics: The Open-Access, Open-Assessment E-Journal, Vol. 4, 2010-13.
http://dx.doi.org/10.5018/economics-ejournal.ja.2010-13
Freeman M and Groom B (2012). Positively Gamma Discounting! Mimeo. Submitted to the Economic Journal, April 2012.
Freeman M., Groom, B., Panipoulou, K., and T., Pantelides (2012). Declining Discount Rates and the role of inflation. (work in
progress).
Hepburn, C., and B. Groom, (2007), Gamma discounting and expected net future value, Journal of Environmental Economics and
Management, 53, 99--109.
http://economics.ouls.ox.ac.uk/12723/1/Hepburn%2C%2520Groom%2520(2006%2C%2520JEEM)%2520Gamma%2520discounting
%2520and%2520ENFV.pdf
Hepburn, C., Koundouri, P., Panopoulou, E., Pantelidis, T. (2009) Social discounting under uncertainty: a cross country
comparison. Journal of Environmental Economics and Management 57, 140-150.
http://www.sciencedirect.com/science/article/pii/S0095069608000703
Newell, R., and W. Pizer, (2003), Discounting the benefits of climate change mitigation: How much uncertain rates increase
valuations? Journal of Environmental Economics and Management, 46, 52--71.
Stern, N., (2007), The Economics of Climate Change: The Stern Review. Cambridge University Press
Weitzman, M.L., (1998), Why the far-distant future should be discounted at its lowest possible rate? Journal of Environmental
Economics and Management, 36, 201--208.
http://www.economics.harvard.edu/faculty/weitzman/files/WhyFarDistantFuture.pdf
Weitzman, M.L., (2001), Gamma discounting, American Economic Review, 91, 260—271
http://www.economics.harvard.edu/faculty/weitzman/files/GammaDiscounting.pdf
Winkler, R. L. (1981), .Combining probability distributions from dependent information sources., Management Science 27, 479.488.
The value of a statistical life
Name:
James Hammitt
Title, organisation:
Professor, Harvard School of Public Health
E-mail/phone:
jkh@harvard.edu, 617 432 4343
Summary:
The value per statistical life
The monetary value of a change in mortality risk is described as the value per statistical life (VSL). VSL is the marginal rate
of substitution between mortality risk in a specified time period and wealth. It may vary between individuals and depend on
many factors, including the period over which risk is changed, baseline risk, wealth, age, life expectancy, future health, the
cause of mortality (e.g., fatal injury, cancer), and the source of the hazard (e.g., motor-vehicle crash, nuclear power plant).
Estimates are based on preferences revealed through market behavior (e.g., choice among jobs differing in occupational
fatality risk) and stated-preference studies. Estimates of the income elasticity, important for projecting the value of future
mortality-risk changes, vary by source. Cross-sectional comparisons within a country suggest values on the order of 0.5 to 1.0
but comparisons between higher and lower income countries, within a country over time, and values derived from estimates of
financial risk aversion suggest values of 1.0 or larger.
Biography:
James K. Hammitt is professor of economics and decision sciences at Harvard University (School of Public Health), director
of the Harvard Center for Risk Analysis, and at the Toulouse School of Economics (LERNA-INRA). His research and
teaching concern the development and application of quantitative methods—including benefit-cost, decision, and risk
analysis—to health and environmental policy. He holds advanced degrees in applied mathematics and public policy from
Harvard, was senior mathematician at RAND, and held the Pierre-de-Fermat chair at the Toulouse School of Economics. He
is a member of the US Environmental Protection Agency Science Advisory Board and chaired the Advisory Council on Clean
Air Compliance Analysis.
Suggested
readings:
Hammitt, J.K., “Valuing Mortality Risk: Theory and Practice,” Environmental Science and Technology 34: 1396-1400, 2000.
Hammitt, J.K., and L.A. Robinson, “The Income Elasticity of the Value per Statistical Life: Transferring Estimates Between
High and Low Income Populations,” Journal of Benefit-Cost Analysis 2(1): Article 1, DOI: 10.2202/21522812.1009, 2011.
Viscusi, W.K., and J.E. Aldy, “The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the
World,” Journal of Risk and Uncertainty 27: 5-76, 2003.
Kochi, I., B. Hubbell, and R. Kramer, “An Empirical Bayes Approach to Combining and Comparing Estimates of the Value
of a Statistical Life for Environmental Policy Analysis,” Environmental and Resource Economics 34: 385-406,
2006.
Valuation of mortality risk in OECD-countries
Name:
Nils Axel Braathen
Title, organisation:
Principal Administrator, Environment Directorate, OECD
E-mail/phone:
Nils-Axel.Braathen@oecd.org, +33 1 45 24 76 97
Summary:
Policy makers are regularly devising policies and regulations that affect people’s risk of death and that seek to protect lives in
society, and require methodologies for comparing the costs of reducing risk with the expected benefits in terms of lives saved.
The presentation will describe recent OECD work helping policy makers get a better measure of such benefits.
We stock of surveys from around the world where people have been asked about their willingness to pay for a small reduction
in mortality risk, and analysed the variation in the estimates resulting from differences in study designs, characteristics of risk,
socio-economic characteristics, and other variables.
Based on this analysis, we developed guidance on how the findings can be included in future assessments of policies that
affect mortality risks, taking into account the income level in the given country, as well as characteristics of the risk change in
question and the population affected by it.
Biography:
Principal Administrator in the Environment and Economy Integration Division, OECD Environment Directorate, since 1998,
working on our database on instruments used for environmental policy, on estimating effective carbon prices in selected
countries, economic valuation of environmental externalities, and on environmental impacts of transport and agriculture.
Suggested
readings:
OECD: 2012 Mortality Risk Valuation in Environment, Health and Transport Policies
http://www.oecd.org/document/15/0,3746,en_2649_37407_49432527_1_1_1_37407,00.html
Henrik Lindhjem, Ståle Navrud, Nils Axel Braathen and Vincent Biausque, Valuing Mortality Risk Reductions from
Environmental, Transport, and Health Policies: A Global Meta-Analysis of Stated Preference Studies
http://www.webmeets.com/files/papers/EAERE/2011/937/Lindhjem%20et%20al%20VSL%20MA.pdf