Gamma discounters are short-termist

Abstract

Weitzman (1998, 2001) proposed a simple "gamma discounting" method to characterize the term structure of discount rates today from the sole distribution of future spot interest rates. This rule which justifies using a smaller discount rate for longer maturities is now used for long-term policy evaluations in the UK, France, Norway, and potentially in the US. But we show that there is no social preference within the discounted expected utility framework that generically supports this pricing model and its underlying criterion, the expected net present value rule. Considering a standard Lucas tree economy, we characterize the term structure from a coherent joint distribution of future spot interest rates and future consumption levels. When future growth rates are positively serially correlated, efficient discount rates today are decreasing with maturity, and the gamma discounting rule yields discount rates that are larger than the efficient ones.

Declining discount rates and the Fisher Effect: Inflated past, discounted future?

“…Our results confirm the widely held view that interest rates and inflation rates are I(1) processes and co-integrated. 21 As a result, the first condition for the Fisher hypothesis, i.e. the condition that y t (m) and x t (m) are co-integrated processes is satisfied.…”

“…The precautionary savings effect therefore increases with the time horizon and the discount rate term structure is declining. When formalizing this argument, though, the devil is in the detail and careful interpretation is needed [21]. The first contribution of this paper, therefore, is to clarify the theoretical motivation for the ENPV approach and the implications this has for empirical work.…”

Reflections—Looking Back at Social Discounting Policy: The Influence of Papers, Presentations, Political Preconditions, and Personalities

“…The resulting term structure declined from 4% to to 1% for horizons of 300 years. There remain numerous concerns about gamma discounting (Freeman and Groom 2015;Heal and Millner 2013;Gollier 2016), yet its simplicity contributed to its policy influence.…”

“…Freeman and Groom (2016) andGollier (2016) discuss the theoretical motives ofWeitzman (1998). See alsoCox, Ingersoll and Ross (1981).…”

How certain are we about the certainty-equivalent long term social discount rate?

“…Most notably Cox et al (1981) argue that "locally certainty" in consumption (c t+1 being perfectly known at time t) justi…es this choice. Gollier (2014), in particular, has argued that this assumption is highly unrealistic.…”