My personal discount rate

15/11/2011 § 2 Comments

I’ve been doing some interesting work with a colleague on perceptions of discount rates. We know what the official NZ rate is: 8%. We are interested in the rate that lurks behind people’s actual decisions, particularly policy decisions. It’s early days, so we are still working on how to capture data and then how to model it.

As you folks who do cost-benefit analysis know, the discount rate is key. Projects that fail at 8% can look quite promising at 3%. When expert advice is overridden — when those all-important benefit-cost ratios are ignored — one interpretation is that a lower discount rate is operating. Yes, there are other, less charitable interpretations.

I decided to look at my own discount rate, using lifetime earnings to date. We’ve seen the statistics. Plumbers have nearly the lifetime earnings of doctors. PhDs don’t necessary pay off over Masters (particularly MBAs).

My result: I’m behind.

At a nil discount rate, my lifetime earnings are just now surpassing what I could have earned with a high school diploma. Any kind of discount rate, and it will be a few years before I’m ahead. At 8%, I’ll pull ahead when my first child graduates from high school. Sigh.

Before I get schooled on this, yes I realise there are other things operating besides the discount rate: personal development, the consumption value of education, reduced uncertainty, etc. Those objections only go to show that figuring out the impact on decisions of discount rates versus other considerations is no small matter. Since the rate is so important in long-term decision-making, it’s worth some effort trying to tease it out.

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§ 2 Responses to My personal discount rate

  • What do you mean “the” discount rate? I think the evidence shows that humans use many discount rates for different kinds of decisions, and most of those rates are hyperbolic. This may make your data collection even more problematic.

    Do you know if anyone at the NZ Treasury is working on time-dependent discount rates? It’s a standard approach to take in the UK, to the point where the UK Treasury Green Book recommends that after 300 years, a discount rate of 1% should be used.

  • Bill says:

    Yes, multiple discount rates make it even more confusing. Part of what we’re trying to understand is which rate policy makers are applying in different contexts. Do they really use the official 8%? Or does the rate change according to the project? (The interaction effect messes with the econometrics.)
    I don’t know whether anyone at Treasury is working on the time-dependent stuff — it would be worth looking into.

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