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Discounting the benefits of future climate change mitigation

This report, by Richard Newell and William Pizer of the independent nonprofit research institute Resources for the Future, highlights an important variable that often goes unexamined in current climate change models: uncertainty in future interest rates. Climate models incorporate discount rates to compare costs and benefits over time-in essence, they tell us how high future benefits need to be to justify spending today. Most climate models choose one rate and hold it constant over the time horizon of the model.

This study questions that conventional approach, arguing that future rates are uncertain. The authors demonstrate that acknowledging uncertainty about future interest rates leads to a higher valuation of the future benefits of reducing greenhouse gas emissions today — regardless of the initial rate one chooses. The authors conclude that, by ignoring uncertainty, current approaches used in economic modelling may be consistently undervaluing the future benefits of current climate change mitigation efforts. The report shows that including the effect of interest rate uncertainty in climate models could raise valuations of mitigation efforts by as much as 95 per cent relative to conventional discounting at a constant rate.