The discount rate is a basic tool of accounting and economics: people and institutions often need to deal with costs and benefits which will arise in the future, and it doesn’t usually make sense to simply value them as if they were happening today. A person expecting pension payments of $1,000 per month in thirty years probably shouldn’t value them as though they had the money in hand today, and neither should the organization that will be making the payouts.

To adjust for the time difference, people doing accounting choose an annual discount rate by which to reduce the value of things expected in the future.

Problematically, however, the compounding effects of this across long periods of time can make the specific rate you choose into the most important feature of the calculation. This has an extreme effect in climate change economics.

In the context of pensions, a recent Economist article explained:

The higher the discount rate, the less money has to be put aside now; American public plans tend to use a discount rate of around 7.5%, based on the investment return they expect to achieve…

A promise to pay a stream of pension payments in the future resembles a commitment to make interest payments on a bond. A bond yield is thus the most appropriate discount rate. But given how low bond yields are, pension deficits would look larger (and required contributions would be much higher) if such a discount rate were used. A discount rate of 4%, for example, would mean the average public pension plan would have a funding ratio of only 45%, not 72%, according to the CRR.

That last bit means that American institutions which owe pensions to employees in the future may have only 45% of the money which is necessary for that purpose, rather than the 72% which they currently believe themselves to possess.

While there is an intellectual and even a moral case for discounting the future, it seems clear that it’s a practice with considerable moral risks associated. We are in a situation where simply by making optimistic assumptions we can reduce the burden which we owe to future generations. If we get things wrong, especially in the multi-century case of climate change, they will have no way to hold us to account.

Psychologically, this may also lead to us ‘discounting the future’ in other ways. If people expect corporate and government pension plans to be broke by the time they retire, it may inspire a super-cautious response of independent personal pension saving, or it may lead to people writing off any hope of financial stability in old age and simply ignoring the risk. Such temptations may be even greater for those who see the massively inadequate response the world is undertaking in relation to climate change and ask whether – even if governments, firms, and individuals did set aside adequate retirement savings in the near future – the world will still be intact enough in the second half of the 21st century for those funds to be meaningful.

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Tiffany

2016-08-22

in Photo of the day

Tiffany working at the Victory Cafe

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Pirate cat 2/2

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Pirate cat 1/2

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In an effort to control my insomnia, I bought some protective goggles which exclude blue light.

On the first night, when I put them on at 9pm, the psychological effect is profound. Suddenly, it seems obvious everywhere that I should be asleep or preparing for sleep.

I will try putting them on sometime between 9pm and midnight for a month or so and report back on the results.

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Hive-LMP

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Mutual deterrence dissolves when one or both sides can remove the opponent’s ability to inflict severe damage in retaliation. In a crisis the side believing that an unacceptably large part of its retaliatory capacity could be suddenly nullified by an opponents forces might be impelled to strike preemptively. The superior side also might be motivated to undertake the first aggressive actions. Regardless of its original intentions, the stronger side could plausibly imagine a seige mentality, a use-them-or-lose them attitude, operating on the weaker side, and reason, rightly or wrongly, that it had better seize the initiative. A condition of vulnerability on both sides would further strengthen incentives for preemptive attack and pose an unacceptable risk of nuclear war. From the perspective of deterrence theory this is the worst of all hypothetical worlds.

Blair, Bruce G. Strategic Command and Control: Redefining the Nuclear Threat. 1985. p. 17 (hardcover)

This is why — as Ronald Reagan never understood — attempts at ballistic missile defence are fundamentally destabilizing.

These dynamics probably also increase the risk of nuclear war between India and Pakistan.

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Massey College common room, Toronto

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After the comparative aimlessness of the long summer, I am looking forward to September. I will be teaching tutorials for a first year Canadian politics course out at U of T Mississauga and persisting with my own PhD research.

I’m looking forward to the resumption of life and lunches at Massey College, meeting new junior fellows, and hopefully seeing an uptick in energy and accomplishment among climate change activists. I’m looking forward to sleeping without sweating, the return of kiting winds after the summer doldrums, and the return of a steady (if inadequate) income.

In a charitable interpretation, the degree to which I prefer term time to the summer ‘break’ is indicative that grad school is a good place to be, even if universities somewhat unnecessarily turn a third of the year into largely unproductive time.

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Orange pom poms

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