Discussion Paper

How Should Benefits and Costs Be Discounted in an Intergenerational Context? The Views of an Expert Panel

Dec 19, 2012 | Kenneth J. Arrow, Maureen L. Cropper, Christian Gollier, Ben Groom, Geoffrey Heal, Richard G. Newell, William Nordhaus, Robert S. Pindyck, William A. Pizer, Paul R. Portney, Thomas Sterner, Richard S.J. Tol, Martin L. Weitzman

Abstract

In September 2011, the US Environmental Protection Agency asked 12 economists how the benefits and costs of regulations should be discounted for projects that affect future generations. This paper summarizes the views of the panel on three topics: the use of the Ramsey formula as an organizing principle for determining discount rates over long horizons, whether the discount rate should decline over time, and how intra- and intergenerational discounting practices can be made compatible.The panel members agree that the Ramsey formula provides a useful framework for thinking about intergenerational discounting. We also agree that theory provides compelling arguments for a declining certainty-equivalent discount rate. In the Ramsey formula, uncertainty about the future rate of growth in per capita consumption can lead to a declining consumption rate of discount, assuming that shocks to consumption are positively correlated. This uncertainty in future consumption growth rates may be estimated econometrically based on historic observations, or it can be derived from subjective uncertainty about the mean rate of growth in mean consumption or its volatility. Determining the remaining parameters of the Ramsey formula is, however, challenging.