How Should the Distant Future be Discounted when Discount Rates are Uncertain?

It is not immediately clear how to discount distant-future events, like climate change, when the distant-future discount rate itself is uncertain. The so-called “Weitzman-Gollier puzzle” is the fact that two seemingly symmetric and equally plausible ways of dealing with uncertain future discount rates appear to give diametrically opposed results with the opposite policy implications. We explain how the “Weitzman-Gollier puzzle” is resolved. When agents optimize their consumption plans and probabilities are adjusted for risk, the two approaches are identical. What we would wish a reader to take away from this paper is the bottom-line message that the appropriate long run discount rate declines over time toward its lowest possible value.discount rate, term structure, climate change, cost-benefit analysis

Patterns of behavior in biodiversity preservation

Conservation budgets are limited, so it is right to ask of biodiversity programs, What should be preserved? How much should be preserved? Where? Recent papers on optimal preservation policy have tried to integrate three considerations: the relative uniqueness of different species or habitats, the degree of risk to their continued survival, and the opportunity cost of the resources needed to enhance their prospects for survival. It is natural to ask, How are we doing? Have biodiversity conservation resources been optimally allocated? What determines government decisions about the preservation of endangered species? The authors submit the first report card, an empirical analysis of U.S. species preservation policy, the best-documented country experience currently available. The authors discuss the most common normative justifications for biodiversity preservation and identify measurable proxies for a subset of those justifications. Proxies include"scientific"species characteristics, such as"degree of endangerment"and"taxonomic uniqueness,"as well as"visceral"characteristics, such as physical size and to what extent a species is considered a"higher form of life."They find that both kindsof characteristics, but especially"visceral"characteristics, influence government decisions on whether to protect a species under the Endangered Species Act. The authors find that"visceral"characteristics- especially physical size and taxonomic class - are also important in explaining how much is spent on endangered species. Perhaps more surprising is their finding that more is spent on animals with lower risk of extinction than on animals with a higher risk of extinction. The author's results are sobering. Many millions have been spent on species preservation, but neither uniqueness nor risk has weighed heavily in resource allocation. Instead there has been a heavy bias toward"charismatic megafauna"- large, well-known birds and mammals ("higher forms of life,"in the human value system). Other classes of fauna - including, say, eels or wild toads - and all flora, have gotten extremely short shrift. Prominent examples of species with high charisma, high attention, and relatively low endangerment are the bald eagle, the Florida scrub jay, and the grizzly bear. Other species may have less charisma but could have more scientific value or species risk.Wildlife Resources,Wetlands,Environmental Economics&Policies,Information Technology,Biodiversity

Bonuses and Employment in Japan

Japan has a relatively unique system of labor compensation. Most Japanese workers are paid large bonuses twice a year. This paper examines the cyclical movement of bonuses compared with wages and the relation of bonuses to employment in the context of the Weitzman "share economy." The paper makes three basic points:(1) The Japanese bonus is much more pro-cyclical than Japanese base wages,but not as cyclically variable as profits. Bonuses can be interpreted as containing a quantitatively significant revenue or profit-sharing component.(2) Bonuses have quite different employment consequences than do base wages. Even after controlling for other economic factors, bonuses are positively related to employment, whereas base wages are negatively related to employment.(3) The bonus system of paying workers, while far from explaining the whole macroeconomic story in Japan, seems to play a role in helping to stabilize Japanese unemployment at comparatively low levels.

The Ramsey Discounting Formula for a Hidden-State Stochastic Growth Process

The long term discount rate is critically dependent upon projections of future growth rates that are fuzzier in proportion to the remoteness of the time horizon. This paper models such increasing fuzziness as an evolving hidden-state stochastic process. The underlying trend growth rate is an unobservable random walk hidden by noisy transitory shocks and recoverable only as a probability distribution via Bayesian updating. A simple expression is derived for the time-declining Ramsey discount rate. The components of this hidden-state Ramsey discounting formula are then analyzed, followed by a few remarks about possible implications and applicationsEconomic

Tail-Hedge Discounting and the Social Cost of Carbon

The choice of an overall discount rate for climate change investments depends critically on how different components of investment payoffs are discounted at differing rates reflecting their underlying risk characteristics. Such underlying rates can vary enormously, from ≈1 percent for idiosyncratic diversifiable risk to ≈7 percent for systematic nondiversifiable risk. Which risk-adjusted rate is chosen can have a huge impact on cost-benefit analysis. In this expository paper, I attempt to set forth in accessible language with a simple linear model what I think are some of the basic issues involved in discounting climate risks. The paper introduces a new concept that may be relevant for climate-change discounting: the degree to which an investment hedges against the bad tail of catastrophic damages by insuring positive expected payoffs even under the worst circumstances. The prototype application is calculating the social cost of carbon.Economic

Additive Damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting

This paper in applied theory argues that there is a loose chain of reasoning connecting the following three basic links in the economics of climate change: 1) additive disutility damages may be appropriate for analyzing some impacts of global warming; 2) an uncertain feedback-forcing coefficient, which might be near one with infinitesimal probability, can cause the distribution of the future time trajectory of global temperatures to have fat tails and a high variance; 3) when high-variance additive damages are discounted at an uncertain rate of pure time preference, which might be near zero with infinitesimal probability, it can make expected present discounted disutility very large. Some possible implications for welfare analysis and climate-change policy are briefly noted.Economic

GHG Targets as Insurance Against Catastrophic Climate Damages

A critical issue in climate change economics is the specification of the so-called “damages function” and its interaction with the unknown uncertainty of catastrophic outcomes. This paper asks how much we might be misled by our economic assessment of climate change when we employ a conventional quadratic damages function and/or a thin-tailed probability distribution for extreme temperatures. The paper gives some numerical examples of the indirect value of various greenhouse gas (GHG) concentration targets as insurance against catastrophic climate change temperatures and damages. These numerical exercises suggest that we might be underestimating considerably the welfare losses from uncertainty by using a quadratic damages function and/or a thin-tailed temperature distribution. In these examples, the primary reason for keeping GHG levels down is to insure against high-temperature catastrophic climate risks.Economic