Page:Technical Support Document - Social Cost of Carbon, Methane and Nitrous Oxide Interim Estimates under Executive Order 13990.pdf/22

 It is important to note that the new information pointing to a lower consumption rate of interest, lower than 3 percent, does not obviate the need to carefully consider issues of uncertainty and ethics when discounting in an intergenerational context. If 2 percent was used as the consumption interest rate and adjusted for uncertainty using the results of Newell and Pizer (2003) as was done in the 2010 TSD, the process would yield a discount rate lower than 2 percent. Therefore, a consideration of discount rates below 3 percent, including 2 percent and lower, are warranted when discounting intergenerational impacts.

This is consistent with the 2003 recommendation in OMB’s Circular A-4 that noted “[a]lthough most people demonstrate time preference in their own consumption behavior, it may not be appropriate for society to demonstrate a similar preference when deciding between the well-being of current and future generations” and found that certainty equivalent discount rates as low as 1 percent could be appropriate for intergenerational problems (OMB 2003). Similarly, if implementing a declining discount rate schedule to account for uncertainty (see next section), an updated consumption rate of interest, based on additional data presented above, may be a starting point for an update.

In light of the evidence and discussion on discount rates presented in this TSD and elsewhere, the recommendation from OMB’s Circular A-4 to include further sensitivity analysis with lower discount rates when a rule has important intergenerational benefits or costs, and the direction to the IWG in E.O. 13990 to ensure that the SC-GHG reflect the interest of future generations, the IWG finds it appropriate as an interim recommendation that agencies may consider conducting additional sensitivity analysis using discount rates below 2.5%.

3.3Analytic Consistency and Declining Discount Rates

While the consumption rate of interest is an important driver of the benefits estimate, it is uncertain over time, as may be observed in Figure 1. Weitzman (1998, 2001) showed theoretically and Newell and Pizer (2003) and Groom et al. (2005) confirmed empirically that discount rate uncertainty can have a large effect on net present values. A main result from these studies is that if there is a persistent element to the uncertainty in the discount rate (e.g., the rate follows a random walk), then it will result in an effective (or certainty-equivalent) discount rate that declines over time. This is because lower discount rates tend to dominate over the very long term (see Weitzman 1998, 1999, 2001; Newell and Pizer 2003; Groom et al. 2005; Gollier 2009; Summers and Zeckhauser 2008; Gollier and Weitzman 2010; Arrow et al. 2013; Cropper et al. 2014; and Arrow et al. 2014).

The proper way to specify a declining discount rate schedule remains an active area of research. One approach is to develop a stochastic model of interest rates that is empirically estimated and used to calculate the certainty equivalent declining discount rate schedule (e.g., Newell and Pizer 2003; Groom et al. 2007). An alternative approach is to use the Ramsey equation based on a forecast of consumption growth rates that accounts for uncertainty (e.g., Cropper et al. 2014; Arrow et al. 2013). If the shocks to consumption growth are positively correlated over time then the result of the Ramsey equation will be a certainty-equivalent discount rate schedule that declines over time (Goiller 2014). Others have argued for a less structural approach to specify a declining discount rate schedule (e.g., Weitzman 2001, the United

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