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Discount rate (changes)

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Discount rate

Idea

In performing analysis or planning, one is often faced with comparing “events” occuring immediately with events occurring at some time in the future. For various reasons (see below), the same event occuring at different times in the future may have different “importances”. The very general term discount rate is a multiplicative factor used to form comparable importance values for events at different times. (Specific fields often have their own specialisations of the term referred to as the discount rate.)

Details

One often considers alternatives which consist of events occuring at different times in the future (including “imminently”). The importance of these events often varies depending upon when they occur. Events’ importances “importances” are often monetary (i.e., (e.g., is it better to receive 100 million dollars now or 95 105 million dollars in after one year) year?) but can be other quantities, e.g., some toy examples are:

  • Is a plan which stabilizes CO 2CO_2 at 400ppm in ten years better than one that that’s that has a much slower reduction but stabilizesCO 2CO_2 at 350 ppm in fifty years?

  • Is exploiting a newly discovered oilfield now or in 20 years time better?

Some of the phenomena that contribue contribute to a choice of discount rate are:

  • The future is uncertain: Often what one really has is a model based prediction of an event at some future time. As the prediction uncertainty increases going further into the future, an annually compounding discount rate causes less weight to be given to a potentially inaccurate predicted situation.

  • Technology will improve: This is a specialisation of the previous reason, where problems which are difficult or expensive to tackle now could be easier to tackle by the time they occur due technological improvements.

  • Let the future take care of itself: This is a combination of the two previous points with a general “human preference” for now compared to the future. This view that current people should deal primarily with immediate problems and that future problems should primarily be dealt with by people at that time is often called inherent discounting.

  • Opportunity cost: This is really related to taking action now in response to something happening in the future, and is designed to reflect the fact that resources used in this way are taken out of use for actions now.

These are all “intellectual reasons” for a discount rate. There is strong evidence that human psychology has an inherent preference for immediate reward over reward in the future, leading to actions which discount the future.

This could certainly be written much better. Unfortunately wikipedia only refers to very narrow examples of discount rate – DavidTweed

Note that this use of the general term discount rate does not refer to the use in economics of the term to denote adjusting for predicted inflation to obtain a measure of currency which has constant “value”. This is something that is often needed in analysis, but the use of the term here is to compare things which have genuinely different impacts depending when they occur.

Disputes over the discount rate used in analyses

Many analyses, particularly for environmental issues, come to conclusions about the best course of action based upon use of discount rates. Frequently these plans are criticised based upon the discount rates used (or rather, the assumptions those discount rates embody are criticised). In particular,

  • setting the discount rate too low biases actions for tackling current events in preference to future events,

  • setting the discount rate too high biases actions for tackling future events in preference to current events.

Examples of disputed discount rates include those in the Stern Review and (cf. Azimuth’s pageStern review) and those for Lomborg’s Copenhagen Consensus reports.

References

TODO: find references to generalised discount rates.

A general discussion, including a section on discount rates:

category: methodology