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Declining Discount Rates: The Long and the Short of it

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Abstract

The last few years have witnessed important advances in our understanding of time preference and social discounting. In particular, several rationales for the use of time-varying social discount rates have emerged. These rationales range from the ad hoc to the formal, with some founded solely in economic theory while others reflect principles of intergenerational equity. While these advances are to be applauded, the practitioner is left with a confusing array of rationales and the sense that almost any discount rate can be justified. This paper draws together these different strands and provides a critical review of past and present contributions to this literature. In addition to this we highlight some of the problems with employing DDRs in the decision-making process, the most pressing of which may be time inconsistency. We clarify their practical implications, and potential pitfalls, of the more credible rationales and argue that some approaches popular in environmental economics literature are ill-conceived. Finally, we illustrate the impact of different approaches by examining global warming and nuclear power investment. This includes an application and extension of Newell and Pizer [‘Discounting the benefits of climate change mitigation : how much do uncertain rates increase valuations?’ Journal of Environmental Economics and Management 46 (2003) 52] to UK interest rate data.

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Authors and Affiliations

  1. Department of Economics, School of Oriental and African Studies, London, UK

    Ben Groom

  2. St Hugh’s College, Environmental Change Institute and Department of Economics, Oxford University, UK

    Cameron Hepburn

  3. Department of Business, Department of Economics, Reading University, UK

    Phoebe Koundouri

  4. Department of Economics, University College London, UK

    David Pearce

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  1. Ben Groom
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  2. Cameron Hepburn
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Correspondence to Ben Groom.

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Groom, B., Hepburn, C., Koundouri, P. et al. Declining Discount Rates: The Long and the Short of it. Environ Resource Econ 32, 445–493 (2005). https://doi.org/10.1007/s10640-005-4681-y

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