A New Look into the Determinants of the Ecological Discount Rate: Disentangling Social Preferences

Abstract

How should changes in environmental quality occurring in the future be discounted? To answer this question we consider a model of “ecological discounting,” where the representative consumer has a utility function defined over two attributes, consumption and environmental quality, which evolve stochastically over time. We characterize the determinants of the social discount rate and its behavior over time using a fairly general preference structure that explicitly disentangles tastes over consumption and environmental quality from attitudes towards risk. We show that the degree of substitutability between consumption and environmental quality, the degree of risk aversion, and the rate at which these attitudes change as natural and man-made resources evolve over time are all important aspects of the ecological discount rate and its term structure. We extend the analysis to consider a specification of social preferences that further disentangles attitudes towards risk from attitudes towards intertemporal inequality. We show that such separation is also crucial for determining the appropriate rate to discount environmental impacts.

Keywords: Social discount rate, ecological discounting, uncertainty, multivariate risk aversion, intertemporal inequality, substitutability