Discounting Future Climate Change and the Equilibrium Real Interest Rate

2020 ◽  
Author(s):  
Michael Bauer ◽  
Glenn Rudebusch
Keyword(s):  
Climate Change ◽  
Interest Rate ◽  
Interest Rates ◽  
Term Structure ◽  
Real Interest Rate ◽  
Discount Rates ◽  
Social Discount Rate ◽  
The Social ◽  
Macro Finance ◽  
Equilibrium Real Interest Rate

<p>The social discount rate is a crucial element required for valuing future damages from climate change. A consensus has emerged that discount rates should be declining with horizon, i.e., that the term structure of discount rates should have a negative <em>slope</em>. However, much controversy remains about the appropriate the overall <em>level</em> of discount rates.</p><p>We contribute to this debate from a macro-finance perspective, based on the insight that the equilibrium real interest rate, commonly known as r*, is the crucial determinant of the level of discount rates. First, we show theoretically how r* anchors the term structure of discount rates, using the modern macro-finance theory of the term structure of interest rates to provide a new perspective on classic results about social discount rates. Second, we show empirically that new macro-finance estimates of r* have fallen substantially over the past quarter century---consistent with a broader literature that documents such a secular decline. Bayesian estimation of a state-space model for Treasury yields, inflation and the real interest rate allows us to quantify both the decline in r* and the resulting downward shift of the term structure of social discount rates. Third, we document that this decline in r* and the social discount rate boosts the social cost of carbon and has quantitatively important implications for assessing the economic consequences of climate change. In essence, we demonstrate that the lower new normal for interest rates implies a higher new normal for the present value of climate change damages.</p>

scholarly journals The Rising Cost of Climate Change: Evidence from the Bond Market

2021 ◽  
pp. 1-45
Author(s):  
Michael D. Bauer ◽  
Glenn D. Rudebusch
Keyword(s):  
Climate Change ◽  
Interest Rate ◽  
Interest Rates ◽  
Term Structure ◽  
Mitigation Strategies ◽  
Social Cost Of Carbon ◽  
Carbon Mitigation ◽  
Interest Rate Models ◽  
Real Rate ◽  
The Social

Abstract Social discount rates (SDRs) are crucial for evaluating the costs of climate change. We show that the fundamental anchor for market-based SDRs is the equilibrium or steady-state real interest rate. Empirical interest rate models that allow for shifts in this equilibrium real rate find that it has declined notably since the 1990s, and this decline implies that the entire term structure of SDRs has shifted lower as well. Accounting for this new normal of persistently lower interest rates substantially boosts estimates of the social cost of carbon and supports a climate policy with stronger carbon mitigation strategies.

scholarly journals The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges

2020 ◽  
Vol 12 (1) ◽  
pp. 305-326
Author(s):  
Michael T. Kiley
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Term Structure ◽  
Real Interest Rate ◽  
Individual Country ◽  
Policy Makers ◽  
Global Trend ◽  
Advanced Economies ◽  
The Individual ◽  
Equilibrium Real Interest Rate

Real interest rates have been persistently below historical norms over the past decade, leading economists and policy makers to view the equilibrium real interest rate as likely to be low for some time. Various definitions and approaches to estimating the equilibrium real interest rate are examined, including approaches based on the term structure of interest rates and small macroeconomic models. The individual country approaches common in the literature are extended to allow for global trend and cyclical factors. The analysis finds that global factors dominate the downward trend in the equilibrium interest rate across 13 advanced economies. A corollary of this finding is that the U.S. equilibrium rate can be informed by global developments and is recently lower than estimated in U.S.-only studies. The analysis also highlights how the common global trend confounds empirical assessments of the determinants of movements in the equilibrium rate and the need to better integrate term-structure and macroeconomic approaches.

scholarly journals DISCOUNTING FOR PUBLIC POLICY: A SURVEY

2017 ◽  
Vol 33 (3) ◽  
pp. 391-439 ◽  
Author(s):  
Hilary Greaves
Keyword(s):  
Climate Change ◽  
Public Policy ◽  
Interest Rates ◽  
Discount Rate ◽  
Ethical Theory ◽  
Time Preference ◽  
Social Discount Rate ◽  
The Social ◽  
Positive Rate ◽  
Technical Details

Abstract:This article surveys the debate over the social discount rate. The focus is on the economics rather than the philosophy literature, but the survey emphasizes foundations in ethical theory rather than highly technical details. I begin by locating the standard approach to discounting within the overall landscape of ethical theory. The article then covers the Ramsey equation and its relationship to observed interest rates, arguments for and against a positive rate of pure time preference, the consumption elasticity of utility, and the effect of various sorts of uncertainty on the discount rate. Climate change is discussed as an application.

Monetary Policy and Unnatural Low Interest Rates: Secular Stagnation or Financial Repression?

2019 ◽  
Vol 70 (2) ◽  
pp. 99-135 ◽  
Author(s):  
Ad van Riet
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Interest Rates ◽  
Real Interest Rate ◽  
Central Banks ◽  
Potential Growth ◽  
Secular Stagnation ◽  
Financial Repression ◽  
Low Interest Rates ◽  
Equilibrium Real Interest Rate

Abstract Market interest rates have been on a declining trend over the past 35 years in all advanced economies, even reaching negative territory in some European jurisdictions. This article reviews two competing explanations for the occurrence of unnatural low interest rates. The secular stagnation hypothesis of Keynesian origin maintains that persistent non-monetary factors have caused a structural excess of desired savings over planned investments which steadily pushed down the equilibrium real interest rate that is consistent with a balanced economy. Major central banks in turn failed to sufficiently lower their monetary policy rates to revive aggregate demand, leading to anaemic economic recoveries and hysteresis effects. By contrast, the financial repression doctrine argues that central banks pursued low interest rates to ease the government budget constraint and serve political objectives. The Austrian School of Economics states that this monetary easing bias sowed the seeds of repeated boom/bust cycles and created economic distortions that dragged down potential growth and the equilibrium real interest rate. The core of the debate appears to be the long-standing controversy about the desirable role for the state in guiding the economy on a higher potential growth path as opposed to relying on the efficiency of market processes in generating prosperity.

scholarly journals CANDIDE et la monnaie

2009 ◽  
Vol 52 (1) ◽  
pp. 75-103
Author(s):  
Jean-Pierre Aubry ◽  
Pierre Duguay
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Term Structure ◽  
Structural Equations ◽  
Reduced Form ◽  
Real Sector ◽  
Short Term ◽  
The Real ◽  
Structure Equations

Abstract In this paper we deal with the financial sector of CANDIDE 1.1. We are concerned with the determination of the short-term interest rate, the term structure equations, and the channels through which monetary policy influences the real sector. The short-term rate is determined by a straightforward application of Keynesian liquidity preference theory. A serious problem arises from the directly estimated reduced form equation, which implies that the demand for high powered money, but not the demand for actual deposits, is a stable function of income and interest rates. The structural equations imply the opposite. In the term structure equations, allowance is made for the smaller variance of the long-term rates, but insufficient explanation is given for their sharper upward trend. This leads to an overstatement of the significance of the U.S. long-term rate that must perform the explanatory role. Moreover a strong structural hierarchy, by which the long Canada rate wags the industrial rate, is imposed without prior testing. In CANDIDE two channels of monetary influence are recognized: the costs of capital and the availability of credit. They affect the business fixed investment and housing sectors. The potential of the personal consumption sector is not recognized, the wealth and real balance effects are bypassed, the credit availability proxy is incorrect, the interest rate used in the real sector is nominal rather than real, and the specification of the housing sector is dubious.

scholarly journals The Relative Tax Gap Hypothesis: An Exploratory Analysis and Application to U.S. Financial Markets

2020 ◽  
Vol 23 (1) ◽  
pp. 35-52
Author(s):  
Richard J. Cebula
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Tax Evasion ◽  
Income Tax ◽  
Real Interest Rate ◽  
Strong Support ◽  
Current Data ◽  
Data Availability ◽  
Ex Ante ◽  
Tax Gap

This study empirically investigates the “relative tax gap hypothesis,” which posits that the greater the size of the relative tax gap, the greater the degree to which the U.S. Treasury must borrow from domestic and/or other credit markets and hence the higher the ex ante real interest rate yield on the Bellwether 30 year U.S. Treasury bond. The study uses the most current data available for computing what is referred to here as the “relative tax gap,” which is the ratio of the aggregate tax gap (the loss in federal income tax revenue resulting from personal income tax evasion) to the GDP level. For each year of the study period, the nominal value of the tax gap is scaled by the nominal GDP level and expressed as a percentage. The study period runs from 1982 through 2016, reflecting data availability for all of the variables. The estimation results provide strong support for the hypothesis. In addition, in separate estimations, evidence is provided that the relative tax gap also acts to elevate the ex ante real interest rate yield on Moody’s Baa-rated long-term corporate bonds. It logically follows, then, that to the extent that a greater relative tax gap leads to higher ex ante real interest rates, it may contribute to the crowding out of corporate investment in new plant equipment associated heretofore with government budget deficits per se.

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