Discounting Climate Change Under Secular Stagnation

Ben Bernanke, recent former Chair of the Federal Reserve, has a new blog.  And he's writing about low interest rates and so-called secular stagnation, a pre-WWII phrase recently resurrected by Larry Summers.

The topic is dismal--hey, they're economists! But for those in the field it's a real hoot to see these titans of economic thought relieved of their official government duties and able to write openly about what they really think.

These two share many views, but Ben has a less dismal outlook than Larry.  Larry thinks we're stuck in a low-growth equilibrium, and low or even negative interest rates are here to stay without large, persistent fiscal stimulus.  Ben thinks this situation is temporary, if long lived.  He writes:
I generally agree with the recent critique of secular stagnation by Jim Hamilton, Ethan Harris, Jan Hatzius, and Kenneth West. In particular, they take issue with Larry’s claim that we have never seen full employment during the past several decades without the presence of a financial bubble. They note that the bubble in tech stocks came very late in the boom of the 1990s, and they provide estimates to show that the positive effects of the housing bubble of the 2000’s on consumer demand were largely offset by other special factors, including the negative effects of the sharp increase in world oil prices and the drain on demand created by a trade deficit equal to 6 percent of US output. They argue that recent slow growth is likely due less to secular stagnation than to temporary “headwinds” that are already in the process of dissipating. During my time as Fed chairman I frequently cited the economic headwinds arising from the aftermath of the financial crisis on credit conditions; the slow recovery of housing; and restrictive fiscal policies at both the federal and the state and local levels (for example, see my August and November 2012 speeches.)
These are good points. But then Larry has a compelling response, too.  I particularly agree with Larry about the basic economic plausibility of  persistent equilibrium real interest rates that are well below zero.  He writes:
Do Real Rates below Zero Make Economic Sense? Ben suggests not– citing my uncle Paul Samuelson’s famous observation that at a permanently zero or subzero real interest rate it would make sense to invest any amount to level a hill for the resulting saving in transportation costs.  Ben grudgingly acknowledges that there are many theoretical mechanisms that could give rise to zero rates. To name a few: credit markets do not work perfectly, property rights are not secure over infinite horizons, property taxes that are explicit or implicit, liquidity service yields on debt, and investors with finite horizons.
Institutional uncertainty seems like a big deal that can't be ignored when thinking about long-run growth and real interest rates (these are closely connected).  People are pessimistic about growth these days, for seemingly pretty good reasons.  Institutional collapse may be unlikely, but far from impossible.  Look at history.  If we think negative growth is possible, savings are concentrated at the top of the wealth distribution, and people are loss averse, it's not hard to get negative interest rates.

Still, I kind of think we'd snap out of this if we had a bit more fiscal stimulus throughout the developed world, combined with a slightly higher inflation target--say 3 or 4 percent.  But keep in mind I'm just an armchair macro guy.

The point I want to make is that these low interest rates, and the possibility of secular stagnation, greatly affects the calculus surrounding optimal investments to curb climate change.  The titans of environmental economics--Weitzman, Nordhaus and Pindyck--have been arguing about the discount rate we should use to weigh distant future benefits against near-future costs of abating greenhouse gas emissions.  They're arguing about this because the right price for emissions is all about the discount rate.  Everything else is chump change by comparison.

Nordhaus and Pindyck argue that we should use a higher discount rate and have a low price on greenhouse gas emissions.  Basically, they claim that curbing greenhouse gas emissions involves a huge transfer of wealth from current, relatively poor to future supremely rich.  And a lot of that conclusion comes from assuming 2%+ baseline growth forever. Weitzman counters that there's a small chance that climate change will be truly devastating, causing losses so great that the future may not be as well off as we expect.  Paul Krugman has a great summary of this debate.

Anyway, it always bothered me that Nordhaus and Pindyck had so much optimism built into baseline projections.  Today's low interest rates and the secular stagnation hypothesis paint a different picture.  Quite aside from climate change, growth and real rates look lower than the 2% baseline many assume, and a lot more uncertain.  And that means Weitzman-like discount rates (near zero) make sense even without fat-tailed uncertainty about climate change impacts.


  1. Exactly! It is quite possible that the high returns used to justify high discount rates were an aberration of the 20th century due to an unprecedented but temporary population and technological boom.

  2. If we discount natural capital at a rate greater than natural capital accumulates, the future value necessarily declines the further out you look, and thus we should use it up now while it is more valuable.

    1. That's part of it. You need demand and price in there, too.

    2. John: It's a bit off topic, but there's a bit more to figuring out the optimal way to manage natural capital. For one, the growth usually depends on the stock. Second, while much of natural resource modeling takes prices as fixed, in reality, the less we consume the higher the price (there's a demand curve, too). Rarely is it efficient to "use it up now".

    3. Ah, well of course. "Use it up now" is my criticism in sarcasm. It seems the rate of natural capital accumulation must be quite small, the addition to top soils, sequestration of carbon and conversion to petroleum, additions to biomass--all these must be very small if not zero. Discounting at economic rates would seriously undervalue natural capital. Yet the services provided, the yield, huge, but low growth.

      But price and demand do not seem to fit into the natural capital world. A good case could be made that the yield on natural capital is entirely consumed, even if we were not here. Otherwise there would be mounting surplus everywhere. Perhaps you're thinking the only demand on natural capital is economic demand.

    4. "Discounting at economic rates would seriously undervalue natural capital."

      That's a hard statement to defend, if you really understand the economics. Actually, in many cases, the economic optimum for managing natural capital is more conservationist than the biological optimum.

      I'd argue that the key problem with have with natural capital management is externalities or the so-called tragedy of the commons. People don't have an incentive to manage natural capital efficiently. So we need regulation to even come close to efficiency.

      Thanks for commenting!

    5. I think I can now infer what you are saying.

      Perhaps it is the connection between the human economy and the natural one that needs price and demand. I am afraid I have no solution there. The value of natural capital in the natural economy vastly exceeds its value in the human economy, by reason of discounting as mentioned. (If human investors are looking for 8% deals and the natural world is offering 0.25%, well, then we have a failure to communicate.) It would seem therefore that the human economy would require some kind of regulatory restraint so as to act as if it had natural economy values. Otherwise the human economy price signal says to just go ahead and use up the natural capital.

  3. Costs of climate change mitigation are overstated. Moving along the production possibilities frontier has no net cost on economy while disrupting much at micro level. We can see this from so many tech driven changes in recent years. Resistance is coming from the usual rent seekers.

  4. There are some larger forces being unleashed that may both contribute to a long period of secular stagnation, but which also may do some of the heavy lifting associated with climate change mitigation. My view is that the cost of energy transition--which we pay for by a reduction in GDP, and/or an increase in the portion of GDP we have to devote to new energy infra--also acts to depress interest rates. Moreover, population growth rates peaked in the 1960's, with the next peak--the annual growth rate--having peaked more recently. With the average-weighted fertility rate of the five most populous nations now dropping (just) below 2.00, the trajectory of global population is turning. (Still growing, but the case for never 9 billion is can now be made reasonably). Finally, there is a wall of savings built up in the OECD, looking to be put to work. (This is the classical portion of the Summer's definition: excess savings over investment). OK. Putting this all together, a couple of conclusions. 1. Like Japan, a much longer period of slow growth than anyone anticipates lies ahead. 2. This acts to depress interest rates, making the ROI on smart public infra projects far liklier to be positive. 3. A wall of capital still needs income to serve aging populations--this income is desperate to invest in income products and guess what, a 0.5 GW solar farm can be thought of as a 25 year long bond. 4. The population trajectory change while encouraging is not enough to avoid the problems with water, arable land, and climate between now and 2050, or so. In conclusion, I say that some trends which we cannot control are working in favor of climate mitigation, and happily, as long as we can get society to agree that the ROI to clean energy is not just positive but wildly positive there's lots of capital available to built it. And now my question: is it policy makers that need convincing, or private allocators of capital?


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