Intergenerational transfers and the social discount rate

This paper investigates the relationship between intergenerational asset transfers and the choice of the discount rate for use in cost-benefit analysis in a model of a competitive overlapping generations economy constrained by a socially managed exhaustible resource. Provided that there are no distortions in capital markets and that all agents hold perfect foresight, cost-benefit techniques will result in a Pareto efficient resource allocation if the discount rate is set equal to the market rate of interest. But since the path of the interest rate depends on the level of intergenerational transfers, cost-benefit techniques do not ensure a socially desirable distribution of welfare between generations; a social optimum will result only if intergenerational transfers are properly chosen and enforced. Decentralized private altruism may result in intergenerational transfers that both present and future individuals would agree are too small if members of the present generation attach positive weight to the general welfare of future generations, not simply their personal descendants. In a world where intergenerational transfers are non-optimal, second-best policy-making may imply a constrained optimum that is inefficient. Together, these findings suggest that cost-benefit analysis is at best a partial criterion to policy formulation that should be used only in conjunction with ethical principles that define the proper distribution of welfare between present and future generations.     

State prices,liquidity, and default

We show, in a monetary exchange economy, that asset prices in a complete markets general equilibrium are a function of the supply of liquidity by the Central Bank, through its effect on default and interest rates. Two agents trade goods and nominal assets to smooth consumption across periods and future states, in the presence of cash-in-advance financing costs that have effects on real allocations. We show that higher spot interest rates reduce trade and as a result increase state prices. Hence, states of nature with higher interest rates are also states of nature with higher risk-neutral probabilities. This result, which cannot be found in a Lucas-type representative agent model, implies that the yield curve is upward sloping in equilibrium, even when short-term interest rates are fairly stable and the variance of the (macroeconomic) stochastic discount factor is 0. The risk-premium in the term structure is, therefore, a monetary-cost risk premium.     

Discount rates and credit markets: Theory and evidence from rural india

Three models of credit markets - (1) the permanent income model, (2) upward sloping credit supply to individual borrowers, and (3) constrained credit due to imperfect enforcement - are tested using credit market data and an experimental study of individuals' discount rates in south India. The permanent income model is rejected by both the discount rate and the credit market data. The discount rate data are consistent with either of the other two models, while the credit market data are consistent with a combination of these two models. Other explanations are found to be insufficient to explain the results of this study.     

The firm demand for liquid assets in an inflationary environment

Measures of inflation and the price level are added to the standard model of liquid asset demand and estimated with cross-section data on Brazilian manufacturing firms over a four-year period characterized by substantial inflation (annual rates of 19, 23, 34 and 35%). Results indicate that economies of scale exist in a model that is stable over time. Interest rates have a strong and elastic impact on liquid asset demand when inflation is explicitly controlled for although this result is not consistent across all subsets of data used. The usual assumption of a unitary price level elasticity of liquid asset demand is rejected and firms appear to conserve on liquid asset holdings as the rate of inflation increases suggesting more careful management of payments flows. Some of these findings contradict those of Ungar and Zilberfarb (1980). There are also some difference in behaviour across ownership groups: Brazilian firms do not exhibit economies of scale while multinationals do; and Brazilian firms adjust actual to desired balances faster than multinational firms.     

The government's time discount rate: Choices and consequences in a dynamic framework

This paper considers a closed macroeconomy where the monetary authority pursues an inflation target and policy outcomes are the consequence of a Nash game between fiscal and monetary authorities. The specification of the macroeconomic framework is characterized by nonlinearities which lead to multiple equilibria with differing stability properties. Employing a calibrated model and simulations derived using the Mathematica package, the stability properties of the economy and the likely choice of equilibrium are examined. Within this framework, the dynamic consequences of different time discount rates for the fiscal authority are investigated, both in a world of certainty and also in a world of uncertainty. It is shown that, in a world of certainty, it will be optimal to choose the fiscal authority's time discount rate equal to the market rate of interest. However, depending on the degree of uncertainty in evaluating the time discount rates of consumers and of the fiscal authority, it may be appropriate to bias the fiscal authority's discount rate above or below the expected interest rate.     

Convex Time Budgets and Individual Discount Rates in the Long Run

The purpose of this study is to use experimental data to estimate individual discount rates and test for hyperbolic discounting over a long time horizon. To do this, we employ the convex time budget experimental approach with cash payments over a 20 year time horizon. To date, there are few experimental studies that explore discount rates beyond a 1 year time horizon. Previous experimental studies that focus on short time horizons find high discount rates, which may not be applicable to decisions that affect outcomes in the distant future. Our findings are quite similar to the average rate of 4.9% found by Grijalva et al. (Environ Resour Econ 59:39–63, 2014), who similarly use a 20 year time horizon, but use the multiple price list elicitation method along with payment via government savings bonds. We find annual discounts rates in the range of 1.9–5.5%, depending on the specific model used. We also find evidence for declining discount rates, and that this hyperbolic pattern of behavior is related to the confidence subjects have in receiving distant-future payments.     

“Overreaction” of Asset Prices in General Equilibrium

We attempt to explain the overreaction of asset prices to movements in short-term interest rates, dividends, and asset supplies. The key element of our explanation is a margin constraint that traders face which limits their leverage to a fraction of the value of their assets. Traders may lever themselves, furthermore, either directly by borrowing short term or indirectly by engaging in futures and options trading, so that the scenario is relevant to contemporary financial markets. When some shock pushes asset prices to a low enough level at which the margin constraint binds, traders are forced to liquidate assets. This drives asset prices below what they would be with frictionless markets. Also, a shock which simply increases the likelihood that the margin constraint will bind can have a very similar effect on asset prices. We construct a general equilibrium model with margin constrained traders and derive some qualitative properties of asset prices. We present an analytical solution for a deterministic version of the model and a simple numerical computation of the stochastic version.Journal of Economic LiteratureClassification Numbers: G1, E0.     

The Evolutionary Theory of Time Preferences and Intergenerational Transfers

At each age an organism produces energy by foraging and allocates this energy among reproduction, survival, growth, and intergenerational transfers. We characterize the optimal set of allocation decisions that maximizes fitness. Time preference (the discount rate) is derived from the marginal rate of substitution between energy obtained at two different times or ages, holding fitness constant. Time preference varies with age in different ways depending on whether an individual is immature or mature, and during the transition between these stages. We conclude that time preference and discount rates are likely to be U-shaped across age.     

A direct test of hyperbolic discounting using market asset data

This paper introduces a framework that generalizes exponential discounting in a net present value model by including a quasi-hyperbolic discount parameter in the asset valuation equation. Using observed market asset data, a statistically significant quasi-hyperbolic parameter is obtained, thus rejecting exponential discounting.     

European Sector Returns and Capital Market Integration

The paper tests European capital market integration at the sector level. It examines the recent trend of sector‐level returns for four European countries, France, Germany, Italy, and the UK, using “return on assets” of a panel of listed firms of these countries for the period 1988–95. Initial findings suggest that sector returns have converged across countries over time. However, when integration is tested within a capital‐asset pricing model framework, the country effect remains strong. The overall results support the view that European capital market integration is under way, but is far from complete.     

Balanced budget vs. Tax smoothing in a small open economy: A welfare comparison

The objective of this paper is to investigate the effect of lending and borrowing constraints on the dynamics of public debt and optimal taxation policy in the context of a general equilibrium model with tax smoothing. The results from the numerical simulation of the model show significant welfare gains, provided that the policymaker is allowed to borrow and lend in order to smooth taxes across time instead of maintaining a balanced budget at all times. Moreover, for a specific process for asset prices, it is also shown that if the government can issue state-contingent debt then overall welfare can be further improved substantially.     

Joint estimation of discount rates and willingness to pay for public goods

We analyze willingness to pay (WTP) for environmental programs whose time periods of benefit and repayment differ, using a net present value framework that identifies parameters of both WTP and personal discount rates. Respondents to a contingent valuation survey focusing on protection of critical habitat buffer zones for the endangered Steller Sea Lion in Alaska were asked their willingness to pay for 1-, 5-, and 15-year repayment periods. We jointly estimate the personal discount rates and WTP via maximum likelihood, and compare with a model assuming a fixed, market discount rate.     

Growth Effects of Bubbles in an Endogenous Growth Model

This paper examines the possibility of the existence of bubbles and their effects on the growth rate by using an endogenous growth model. A necessary and sufficient condition for the existence of steady-state equilibrium with bubbles is provided. If non-zero rates of the useless asset supply are allowed, a steady-state equilibrium with bubbles exists even if the growth rate of the bubbleless equilibrium is lower than the market interest rate. The growth rate in the steady state with bubbles depends positively on the supply rate of the useless asset. Dynamic properties of bubbles are also analysed.
JEL Classification Numbers: E52, O41, O42.     

CAN FINANCING CONSTRAINTS EXPLAIN THE ASSET PRICING PUZZLES IN PRODUCTION ECONOMIES?*

General Equilibrium asset pricing models have a difficult time simultaneously delivering a sizable equity premium, a low and counter cyclical real risk free rate, and cyclical variation in return volatility. To explain these stylized facts, this article introduces occasionally binding financing constraints that impede producers’ ability to invest. The financial frictions drive a wedge between the marginal rate of substitution and firms’ internal stochastic discount factors so that the shadow value of capital is not tied to the average price of capital. The model delivers higher and more volatile asset returns during recessions as well as a counter cyclical equity premium.     

Temporal insensitivity of willingness to pay and implied discount rates

A number of studies have defined and tested the temporal sensitivity of willingness to pay to payment schemes and the resulting implied discount rates for environmental projects. We demonstrate that those studies have imposed restrictive assumptions on the structure of the willingness to pay function and the underlying decision process. We investigate the temporal sensitivity of willingness to pay using a new temporal willingness to pay function applied to a proposed oyster reef restoration program. We find that (1) holding the length of the project constant, the temporal willingness to pay for the project is the same across different payment schemes, (2) temporal willingness to pay does not vary significantly across projects of varying lengths, and (3) estimated discount rates are low relative to previous studies, but vary significantly across payment schemes and project lengths.     

The impact of macroprudential policies on the transmission of shocks across financially integrated countries

We study the implications of macroprudential policies across countries on the transmission of shocks when international investment activities are allowed. In a two-country dynamic stochastic general equilibrium (DSGE) model in which international investors are borrowing constrained and pledge international assets, we introduce a time-varying loan-to-value (LTV) ratio that adjusts to the variation of three different financial vulnerability indicators. We examine the effect of these policies on negative productivity and borrowing capacity shocks. Although time-varying LTV ratios reduce the international propagation of the productivity shock, their response to the shock depends on the financial vulnerability indicator with which the LTV ratio changes. With a productivity shock, the adjustment of the LTV ratio to the deviation of credit or asset price helps to reverse the negative impact of the shock. With a financial shock, LTV ratios varying with a deviation of credit-to-GDP ratio or aggregate credit can mitigate the impact of a negative financial shock. Adjustment of the LTV ratios reduces the fluctuation of international investors' balance sheets, investment, and productivity. We find that countries improve their welfare when time-varying LTV ratios are in place. The magnitude of the welfare gain differs with both the financial vulnerability indicator and the shock.     

Balance sheet changes and the impact of financial sector risk-taking on fiscal multipliers

We analyse implications of financial sector dynamics for fiscal expenditure multipliers in recessionary conditions. A new stock-flow consistent model is developed in which a financial sector with four financial instruments is integrated with the real sector. The transmission of policy innovations occurs through balance sheet effects. Higher government expenditure increases aggregate demand in the economy. This reduces the perceived probability of default on financial institutions’ loans, increases asset valuations, and leads financial institutions to reduce interest rate spreads. Expectations of higher future wealth and a reduction in credit constraints supports consumption growth. Stronger balance sheets across institutions and lower interest rates increase investment. The interaction between growth and balance sheet valuations creates financial accelerator effects though its impact on financial sector risk-taking. Inflows of foreign savings can increase the multiplier further than would be the case in a closed economy constrained by domestic savings. The results show that fully modelling interactions between real and financial sectors generates fiscal multipliers higher than have been found for South Africa in other types of model.     

The Ramsey Discounting Formula for a Hidden-State Stochastic Growth Process

The long term discount rate is critically dependent upon projections of future growth rates that are fuzzier in proportion to the remoteness of the time horizon. This paper models such increasing fuzziness as an evolving hidden-state stochastic process. The underlying trend growth rate is an unobservable random walk hidden by noisy transitory shocks and recoverable only as a probability distribution via Bayesian updating. A simple expression is derived for the time-declining Ramsey discount rate. The components of this hidden-state Ramsey discounting formula are then analyzed, followed by a few remarks about possible implications and applications.     

Intertemporal Valuation of River Restoration

Willingness to pay for an environmental improvement is a function of how long it takes to deliver the improvement. To measure the effect of time on benefits, I utilize a discrete choice experiment that includes an attribute for delay until the improvement occurs and simultaneously estimate discount rates and valuation parameters. I estimate the present value of immediate and delayed Minnesota River Basin improvements using discount rates directly estimated from the econometric model. Compared to an immediate river basin cleanup, Minnesota residents lose almost half of the benefits when cleanup is delayed by 5 years.     

Discounting the Distant Future: An Experimental Investigation

We use a laboratory experiment to elicit discount rates over a 20-year time horizon using government savings bonds as a payment vehicle. When using a constant (exponential) discount rate function, we find an implied average discount rate of 4.9 %, which is much lower than has been found in previous experimental studies that used time horizons of days or months. However, we also find strong support for non-constant, declining discount rates for longer time horizons, with an extrapolated implied annual discount rate approaching 0.5 % in 100 years. There is heterogeneity in discount rates and risk preferences in that people with more optimistic beliefs about technological progress have higher discount rates. These findings contribute to the debate over the appropriate discount rate to use in comparing the long-term benefits of climate change mitigation to the more immediate costs.