New discount rate pub
05/12/2011 § 6 Comments
On Friday, NZIER (where I work) published an Insight about discount rates. Chris Parker has collected some thoughts and questions about discount rates and policy. Specifically, he is interested in whether Treasury’s 8% is the right number. The work has come out of our preparations for the visit of Prof Martin Weitzman, who is in Wellington this week.
Discount rates are one of those pointy-head policy details that are actually really important. I remember working on business loss valuations many years ago, and discovering just how much difference the assumed rate made to the value of losses.
They are prominent in the climate change area. The results in the Stern report were heavily influenced by the 1.4% discount rate used. The report came in for a lot of criticism for using such a low rate. So, just as an example, take $1,000 in damages that will occur in 25 years. At the Stern rate, the present value is about $700; at the Treasury rate, the present value is around $150. That makes a big difference to a benefit-cost ratio.
I’m glad to see Chris working on raising the issue. Because it is so central to evaluating long-term investments, it’s worth thinking about and getting right.