Thursday, November 23, 2006

Hepburn and Klemperer report to Stern on discount rates...

The Stern report choice of discount rates is based on a commissioned report from Cameron Hepburn and Paul Klemperer. With our usual encouragement that thee should RTFR, we reproduce their conclusions:

1. Future climate policy may involve action on such a large scale as to shift our economic path in a non-marginal fashion. Under such circumstances, conventional discounted cost-benefit analysis is inapplicable. Instead, analysis should proceed using a utility discount rate to compare the stream of social welfare with and without the climate policy.

2. The utility discount rate, δ, used for social decision-making should not be estimated based upon revealed individual impatience, but should reflect the risk of societal collapse. On this basis, the appropriate utility discount rate is smaller than the current HM Treasury rate of 1.5%, and although it is positive, δ is probably below 0.5% and possibly 0% to a first approximation.
Note that this was the root of Eli's set to with one of the Aussie Tims.

3. Probabilistic forecasts of future growth rates should be used to determine certainty- equivalent shadow consumption discount rates. These will decline with time in the long run. They will also be different for different countries.

4. No specific schedule of declining discount rates for the UK is recommended here, because this should be based upon estimates of the distribution of future growth rates. Nevertheless, point 2 above suggests that the resulting schedule is likely to be lower from t=0 onwards than current HM Treasury guidance.

5. Concerns about time inconsistency are relatively minor, and only arise with a declining utility discount rate, δ. (Point 2 suggests δ is both very small and constant.)
For those of you in the US, reading the report has certain advantages over a football overdose. Goodnight, Mrs. Calabash, wherever you are.

1 comment:

William M. Connolley said...

But how does Stern justify an exceptional discount rate, when by his own account costs are only about 1% of GDP. Why is the other 99% of GDP being spent with the normal discount rate?