Pure Rate Of Time Preference Research Articles

Changing the Discount Rate by Adjusting the Pure Rate of Time Preference

The Ramsey (1928) equation decomposes the real discount rate into the pure rate of time preference plus a term that accounts for the changing marginal utility of consumption. Discussions about the appropriate discount rate to apply in Cost Benefit Analysis sometimes refer to variations induced by alternative values of the pure rate of time preference as if the two vary on a one-to-one basis. But the optimal consumption path, which determines the marginal product of capital and hence the discount rate, depends on the rate of time preference. Hence the discount rate depends on time preference through the marginal utility term. We derive an analytical expression of this relationship and show that the derivative of the discount rate with respect to time preference only equals unity in the steady state and converges from below. We estimate the derivative using US data from 1930 to 2015. Based on a semi-parametric regression model with time-varying coefficients we find it is about 0.9, but we cannot rule out 1.0 being included in the 95% confidence interval. The implied pure rate of time preference after 1980 is about 1.6 percent.

Social bias, not time bias

People seem to have pure time preferences about trade-offs concerning their own pleasures and pains, and such preferences contribute to estimates of people's individual time discount rate. Do pure time preferences also matter to interpersonal welfare trade-offs, including those concerning the welfare of future generations? Most importantly, should the intergenerational time discount rate include a pure time preference? Descriptivists claim that the intergenerational discount rate should reflect actual people's revealed preferences, and thus it should include a pure time preference. Prescriptivists claim that the intergenerational discount rate should be based on moral analysis, and thus they (often) claim that the rate of pure time preference should be zero. I argue that regardless of which view is correct, a focus on pure time preference is misplaced. First, the most plausible interpretation of descriptive preferences for intergenerational trade-offs is that people are socially biased and not time biased. Second, social bias is superior to time bias as a prescriptive reason to discount the welfare of future people. Third, recent advances in measuring social bias as a social discount rate make social bias a viable replacement for time bias in economic analyses of intergenerational welfare trade-offs.

To weigh or not to weigh. Recommendations for communicating aggregated results of buildings LCA

Interpreting contradictory results of multiple midpoint environmental indicators is challenging task. Hence, partial or full aggregation into building single scores has gained ground for the clear message they convey. This paper helps to improve understanding of the possibilities and limitations of such practice. Partial aggregated scores of five buildings were explored, limited to the environmental indicators shared by the methods examined and inventoried for the case studies. In general, the buildings’ single score ranking was maintained regardless of the aggregation approach, but rank reversal is possible if e.g., ecotoxicity impact indicators are considered. Such indicators are directly influenced by the mass of metals used in a building. Furthermore, uncertainties on their results, in LCI data and in impact and damage assessment are high, and experience with them is still limited. No single best aggregation stands out per se. All of them can play their part if officially supported to ensure that coherent weights/factors are built upon solid, up-to-date data and fair intergenerational and income equity valuation procedures. In such cases, LCA practitioners are encouraged to use single scores in addition to environmental profiles or selected indicators. Overall aggregation procedures shall be transparently described, and zero pure time preference rate and equity weighting applied and explicitly declared. Sensitivity/uncertainty analysis shall be performed to assess results robustness, potential ranking reversal risks, and the effect of different discount rates. When partial aggregation is alternatively pursued, it shall be based on endpoint categories.

Social discounting, inequality aversion, and the environment

Measures of inequality aversion are elicited using hypothetical decision tasks. The tasks require an assessment of projects in the presence of environmental inequalities across space and time. We also test the effect of different environmental domains (air pollution, recreational forest and soil fertility) and contextual framings (gain/loss, within/between regions and present–future/past–present inter-temporal trade-offs). Estimated mean inequality aversion is higher in the intra-temporal framing (an elasticity of 2.9), than in the inter-temporal framing with either negative (2.0) or positive (1.4) growth in environmental quality. Differences across environmental domains exist but are less pronounced. Similar results hold for pure time preference. Losses are associated with a lower pure rate of time preference but higher inequality aversion compared to gains. The results indicate how domain-specific ‘dual’ discount rates or rather changing relative shadow prices for the environment might be calibrated. Yet, seen as an exercise in empirical social choice, the context dependent results reject the classical Utilitarian formulation of a single Ramsey Rule.

Discounting and Global Environmental Change

Discounting plays a central role in decisions about global environmental change that affect the well-being of future generations. Discounting the future more heavily tilts decisions toward the present, making it less likely that society will undertake actions to mitigate climate change or other global environmental change. This article reviews the standard economics approach to discounting that emerges from solving for optimal savings and investment through time. Discounting depends on the pure rate of time preference and differences in consumption levels across time, giving rise to different marginal utilities of consumption. Discounting for problems like climate change that impact future generations involves an ethical dimension. This article includes discussions of ethical dimensions of discounting related to intragenerational and intergenerational equity and also covers behavioral economics, ecological economics, and mainstream economics approaches to discounting. The article closes with a review of the debates over discounting in climate change policy.

Can Low Retirement Savings Be Rationalized?

Simple presentations of the life cycle model often suggest a constant level of real consumption in retirement. Similarly, financial planners commonly suggest that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working. However, constant consumption with age is only optimal under the precise and unlikely condition that the subjective rate of time preference is equal to the real interest rate. Most people exhibit a positive rate of pure time preference, and additionally discount the future by both mortality and morbidity risks. In comparison, the real interest rate is roughly 0%—and the term structure of interest rates suggests this condition is likely to persist. These considerations suggest that optimal consumption in the life cycle model declines with age. This finding has major implications for optimal retirement saving. For instance, we find that for many, perhaps most, people in the bottom half of the lifetime earnings distribution, it is optimal to spend out their retirement wealth well before death and to live on Social Security alone after that. Very low earners may find it optimal to not engage in retirement saving at all. <b>TOPICS:</b>Long-term/retirement investing, portfolio theory <b>Key Findings</b> ▪ Under plausible assumptions, optimal consumption in the life cycle model declines with age. ▪ For many people in the bottom half of the lifetime earnings distribution, it is optimal to spend out retirement wealth well before death and live on Social Security alone after that. ▪ These results stand in contrast to standard financial planning advice that people save for retirement in such a way as to enable them to maintain a level retirement standard of living equal to their standard of living while working.

Discount Rate Determination for Economic Evaluations in HTA in the Philippines

Abstract To inform the development of a reference case for economic evaluation, we explored various approaches to determine a base case discount rate and rate options for discounting benefits and costs. We conducted literature review and expert consultations to list approaches to determine base case discount rates, noting the advantages and disadvantages of each approach. The same methods were used to identify whether different discount rates would be applied to costs and benefits. We computed a social rate of time preference using the Ramsey formula: rc = ρ+μg, where ρ = pure rate of time preference μ= elasticity of the marginal utility of consumption and g= growth rate in per capita income. We assumed ρ = 1%, μ = 1.4% consistent with international practice, but used actual g of the Philippines of 4.5%. We compared this with the official social discount rate and with rate most commonly used internationally. These options were presented to the Philippine Health Technology Assessment Council for decisionmaking. Based on reviewed literature, 10 out of 22 countries used a 3.0% to 3.5% discount rate while 18 countries from the same pool applied equal discount rates for both costs and outcomes. The official social discount rate (SDR) prescribed by the Philippine National Economic Development Authority is 10% for all social investments. Upon input of the values, rc was calculated at 7%, which is above the international norm but below the official rate. Four discount rate options were identified: 3%, 3.5%, 7% and 10%. Evidence suggested using a discount rate higher than 3% to 3.5% for low-to-middle income countries. A more conservative rate based on the Ramsey formula of 7% base case discount rate was selected in performing economic evaluations. Sensitivity analysis was set between 3% and 10% to allow benchmarking with international practice and with the official SDR, respectively. Given Philippines' early HTA implementation phase, it was agreed to subject these rates to regular review. Key messages Setting a discount rate in economic evaluations is a crucial process for HTA institutionalization. Discount rate determination heavily relies on decision context a country considers most relevant.

A social cost of carbon for (almost) every country

This paper uses imputed national climate change impact functions to estimate national social costs of carbon, which are largest in poor countries with large populations. The national social costs of carbon of faster growing economies are less sensitive to the pure rate of time preference and more sensitive to the rate of risk aversion. The pattern of national social costs of carbon is not sensitive to the assumed impact function, climate sensitivity, and scenario, although the global social cost of carbon is. Income convergence raises the national social costs of carbon of poorer countries, and lowers them for richer countries. Both global and national social costs of carbon are most sensitive to the income elasticity of climate change impacts, a parameter about which we know little.

Estimates of the social cost of carbon: A review based on meta-analysis

There is a great deal of evidence that climate change affects socioeconomic systems. The social cost of carbon (SCC) is calculated by scientists to monetarize the incremental unit of carbon emission and is used to assess climate policies. This study begins with a review of current research on the SCC, followed by a discussion of the choice of models for the SCC. We give a list of advantages of disadvantages of each model and finally use a meta-analysis to evaluate the SCC from published research. The main findings were as follows. (i) Integrated assessment models (IAMs) are often employed to assess the SCC, research on IAMs was started booming in the 1990s and slightly decreased after 2012. (ii) The estimated SCC ranges from −50 to 8752$/tC (−13.36–2386.91$/tCO2), with a mean value of 200.57$/tC (54.70$/tCO2) and it equals to 112.86$/tC (30.78$/tCO2) with a PRTP at 3% in peer-reviewed studies. (iii) The estimated SCC is higher in newer publication year and in peer-reviewed studies, the same trend happens with a higher climatic sensitivity and employing DICE/RICE and PAGE. (iv) The pure rate of time preference (PRTP) is tightly associated with the estimated SCC, and a higher PRTP has a lower estimated SCC. (v) The outliers often appear without realistic scenario setting and in studies have not peer-reviewed.

Discounting by committee

We study a dynamic social choice problem in which a sequence of committees must decide how to consume a public asset. A committee convened at time t decides on consumption at t, accounting for the behaviour of future committees. Committee members disagree about the appropriate value of the pure rate of time preference, but must nevertheless reach a decision. If each committee aggregates its members' preferences in a utilitarian manner, the collective preferences of successive committees will be time inconsistent, and they will implement inefficient consumption plans. If however committees decide on the level of consumption by a majoritarian vote in each period, they may improve on the consumption plans implemented by utilitarian committees. Using a simple model, we show that this occurs in empirically plausible cases. Application to the problem of choosing the social discount rate is discussed.

A generalization of Ramsey rule on discount rate with regime switching

I generalize the following rule of Ramsey (1928) on the discount rate with regime switching: the discount rate is the sum of the rate of pure time preference and the product of the consumption elasticity of marginal utility and the consumption growth rate. The Ramsey rule can be extended to regime-dependent interest-rate formulas for discounting future regime changes. Notwithstanding debate about empirically plausible values of the rate of pure time preference, I theoretically show that the effect of pure time preference is overwhelmingly dominated by the effect of the regime switching parameter. This is closely associated with consumption smoothing consequences across regimes.

DISCOUNTING FOR PUBLIC POLICY: A SURVEY

Abstract:This article surveys the debate over the social discount rate. The focus is on the economics rather than the philosophy literature, but the survey emphasizes foundations in ethical theory rather than highly technical details. I begin by locating the standard approach to discounting within the overall landscape of ethical theory. The article then covers the Ramsey equation and its relationship to observed interest rates, arguments for and against a positive rate of pure time preference, the consumption elasticity of utility, and the effect of various sorts of uncertainty on the discount rate. Climate change is discussed as an application.

DOES A DISCOUNT RATE MEASURE THE COSTS OF CLIMATE CHANGE?

Abstract:I argue that the use of a social discount rate to assess the consequences of climate policy is unhelpful and misleading. I consider two lines of justification for discounting: (i) ethical arguments for a ‘pure rate of time preference’ and (ii) economic arguments that take time as a proxy for economic growth and the diminishing marginal utility of consumption. In both cases I conclude that, given the long time horizons, distinctive uncertainties, and particular costs and benefits at stake in the climate context, discount rates are at best a poor proxy for the normative considerations they are meant to represent.

A Generalization of Ramsey's Rule on Discount Rate with Regime Switching

In this paper I generalize the following rule of Ramsey (1928) on the discount rate with regime switching: the discount rate is the sum of the rate of pure time preference and the product of the consumption elasticity of marginal utility and the consumption growth rate. The Ramsey rule can be extended to regime-dependent interest-rate formulas for discounting future regime changes. Notwithstanding debate about empirically plausible values of the rate of pure time preference, I theoretically show that the effect of pure time preference is overwhelmingly dominated by the effect of the regime switching parameter. This is closely associated with the consumption smoothing consequences across regimes.

Models-as-usual for unusual risks? On the value of catastrophic climate change

We study the role of intertemporal preference representations in a model of economic growth, stock pollutant and endogenous risk of catastrophic collapse. We contrast two polar instances of risk-sensitive preferences: the traditional “discounted utility” model, which imposes a positive rate of pure time preference and risk neutrality with respect to intertemporal utility, and multiplicatively separable preferences, which display risk aversion in that dimension but no pure time preferences. We show that both representations of preferences can rationalize the same economy when there is no collapse risk associated with pollution. Once we introduce a collapse risk whose hazard rate depends on the pollution stock, multiplicatively separable preferences are associated with a much higher value of catastrophic risk reduction, and a more stringent policy response. A relatively high discount rate may thus be compatible with large emissions abatement in the face of a low probability large impact event, reflecting preferences for catastrophic risk reduction.

Discounting Disentangled: An Expert Survey on the Determinants of the Long-Term Social Discount Rate

We present evidence from a survey of 197 experts on the determinants of the long-term social discount rate (SDR). The survey disentangles central discounting concepts and components. Alongside forecasts of real risk-free interest rates and experts’ recommended SDRs, we elicit responses on the individual parameters of the Ramsey Rule’s social rate of time preference: the elasticity of marginal utility of consumption, the pure rate of time preference, and a prediction of long-term per capita consumption growth. Obtaining disentangled data such as these is crucial because appropriate guidance on the SDR depends on how heterogeneous recommendations and forecasts on the SDR’s determinants are combined. We find a mean (median) recommended long-term SDR of 2.25% (2%) and characterise empirical distributions of all other determinants. Besides providing this necessary raw data, which may also prove useful in other fields, we obtain three key results. First, while there is considerable disagreement on point SDRs, 92% of experts are comfortable with SDRs somewhere in the interval of 1% to 3%. Second, we find that the simple Ramsey Rule cannot predict the responses of the majority of experts. In fact, 81% of experts do not recommend a SDR equal to the Ramsey Rule’s social rate of time preference. Furthermore, the SDR responses of only 25% of experts match their forecasted interest rates. This indicates that the prominence of the Ramsey Rule in policy guidance should be revisited. Finally, the rich body of qualitative responses we received underscores the more complex nature of social discounting. Among others, experts point to issues such as uncertainty, heterogeneity, relative price effects and alternative ethical approaches that policy guidance on social discounting should consider. Overall, our findings lead us to the conclusion that current policy guidance concerning social discounting and the evaluation of long-term public projects needs to be updated. This applies among others to the UK Treasury’s Green Book and the Assessments of the Intergovernmental Panel on Climate Change.

Equilibrium resource management with altruistic overlapping generations

We imbed a classic fishery model, where the optimal policy follows a Most Rapid Approach Path to a steady state, into an overlapping generations setting. The current generation discounts future generations׳ utility flows at a rate possibly different from the pure rate of time preference used to discount their own utility flows. The resulting model has non-constant discount rates, leading to time inconsistency. The unique Markov Perfect equilibrium to this model has a striking feature: provided that the current generation has some concern for the not-yet born, the equilibrium policy does not depend on the degree of that concern.

Equilibrium Resource Management with Altruistic Overlapping Generations

We imbed a classic fishery model, where the optimal policy follows a Most Rapid Approach Path to a steady state, into an overlapping generations setting. The current generation discounts future generations' utility flows at a rate possibly different from the pure rate of time preference used to discount their own utility flows. The resulting model has non-constant discount rates, leading to time inconsistency. The unique Markov Perfect equilibrium to this model has a striking feature: provided that the current generation has some concern for the not-yet born, the equilibrium policy does not depend on the degree of that concern.

Intergenerational Inequality Aversion, Growth, and the Role of Damages: Occam’s Rule for the Global Carbon Tax

We derive a simple rule for a nearly optimal carbon tax that can be implemented and tested in a decentralized market economy. Our simple rule depends on the effect of the pure rate of time preference, growth, and intergenerational inequality aversion and basic parameters of the carbon cycle, but also on any adverse effects of global warming on economic growth and mean reversion in climate damages. The performance of the simple rule is excellent and yields only negligible welfare losses compared with the true welfare optimum under a wide range of perturbations including some extreme runs designed to severely road test the rule. Our IAM allows for scarce fossil fuel and endogenous energy transitions and generates cumulative carbon emissions and stranded assets which are also well predicted by our rule.

Viable Ramsey economies

AbstractThe Ramsey model of economic growth is revisited from the perspective of viability theory. The Ramsey model, augmented with minimal consumption and sustainability criteria, becomes a viability problem. The framework allows for a clear picture of optimal viable, optimal non‐viable, and viable non‐optimal paths. The drastic sacrifices in terms of present consumption required by the implementation of Brundtland sustainability are visualized, the rich countries bearing the major part of the burden. The econometric analysis of viability sets enhances the role of technological progress in ensuring Brundtland sustainability. Preference parameters such as the pure time preference rate are statistically non‐significant.