A Discounting Rule for the Social Cost of Carbon

Virtual Seminar
Washington, DC 20460
United States

Contact: Carl Pasurka, 202-566-2275 ([email protected])

Presenter:  Brian Prest (Resources for the Future)

Description:  We develop a discounting rule for use in estimating the Social Cost of Carbon when consumption growth is uncertain, as recommended by a formative National Academies of Sciences study (NAS 2017). We estimate the key discounting parameters in a Ramsey-like framework by combining evidence on the long-run term structure of interest rates (Newell and Pizer 2003; Groom et al. 2007; Freeman et al. 2015; Bauer and Rudebusch 2020) with projected distributions of economic growth rates (based on Muller, Stock and Watson 2019). Theory recommends a relationship between the term structure of interest rates and the distribution of future economic growth rates (e.g., Gollier 2014), whose parameters govern the level and speed of decline of future certainty equivalent interest rates. In the classic Ramsey framework, these parameters reflect the rate of pure time preference and the elasticity of the marginal utility of consumption. We leverage this relationship to estimate the parameters that best match empirical evidence on the term structure and growth rate distribution, while also maintaining consistency with discount rates used for shorter-term benefit-cost analysis. This results in an empirically driven discounting rule to be used in estimating the Social Cost of Carbon in an integrated assessment framework, where uncertain economic growth can underpin both damage estimates and discount rates in a consistent manner.