Question

Those in favour of immediate reductions in fossil fuel consumption to reduce global warming typically use a very low discount rate, i.e., close to zero. Those who are critical use a discount rate closer to 3%. Explain why discounting consumption in the future is implied by positive interest rates. Explain why the appropriate discount rate is an important consideration in the optimum policy response to global warming.

Answer 1

Positive interest means a positive opportunity cost. This means, delaying any consumptin today should be compensated by higher consumption tomorrow.

Appropriate discount rate is necessary because even a slight error in calculating discount rates may have a huge impact due to the non-linear effects of discount rates. This can severely under/over state the net benefits supposed to be derived as a result of chosing a particular course of action over the another.