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Declining discount rates and the Fisher Effect: inflated past, discounted future?

Freeman, Mark C. and Groom, Ben and Panopoulou, Ekaterini and Pantelidis, Theologos (2015) Declining discount rates and the Fisher Effect: inflated past, discounted future? Journal of Environmental Economics and Management, 73. pp. 32-49. ISSN 0095-0696

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Identification Number: 10.1016/j.jeem.2015.06.003

Abstract

Uncertain and persistent real interest rates underpin one argument for using a declining term structure of social discount rates in the Expected Net Present Value (ENPV) framework. Despite being controversial, this approach has influenced both the Inter-Agency Working Group on Cost–Benefit Analysis and the UK government׳s guidelines on discounting. We first clarify the theoretical basis of the ENPV approach. Then, rather than following previous work which used a single series of U.S. Treasury bond returns, we treat nominal interest rates and inflation as co-integrated series and estimate the empirical term structure of discount rates via the ‘Fisher Effect’. This nests previous empirical models and is more flexible. It also addresses an irregularity in previous work which used data on nominal interest rates until 1950, and real interest rates thereafter. As we show, the real and nominal data have very different time series properties. This paper therefore provides a robustness check on previous discounting advice and updated methodological guidance at a time when governments around the world are reviewing their guidelines on social discounting. The policy implications are discussed in the context of the Social Cost of Carbon, nuclear decommissioning and public health.

Item Type: Article
Official URL: http://www.sciencedirect.com/science/journal/00950...
Additional Information: © 2015 Elsevier Inc
Divisions: Geography & Environment
Subjects: H Social Sciences > HA Statistics
H Social Sciences > HC Economic History and Conditions
J Political Science > JA Political science (General)
JEL classification: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods: General > C13 - Estimation
C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Other Model Applications
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Determination of Interest Rates; Term Structure of Interest Rates
Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q4 - Energy > Q48 - Government Policy
Sets: Departments > Geography and Environment
Date Deposited: 23 Oct 2015 16:03
Last Modified: 17 Dec 2016 00:00
URI: http://eprints.lse.ac.uk/id/eprint/64143

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