Economic Analysis of Extreme Climate Change and Long-Term Discounting

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

"Economic Analysis of Extreme Climate Change and Long-Term Discounting" 1: Intellectual Merit A: The proposed project will attempt to put on a more solid analytical and empirical foundation the economic analysis of extreme climate change. This is potentially an important area of research because some preliminary work seems to indicate that low-probability high-impact events may play a bigger role in the economics of climate change than an analysis based on certainty-equivalent measures of central tendency might indicate. A variety of theoretical mechanisms or pathways that could broaden and fatten the extreme tails of the probability distribution of climate-change impacts will be investigated and modeled. Very rough empirical estimates will then be made about "confidence levels" of possible temperatures and damages as a function of atmospheric CO2 concentrations. B: A second aspect concerns what should be done to discount the distant future in a world where the distant-future discount rate itself is uncertain. The proposed project will extend previous analyses of long-term discount rates that decline over time by incorporating optimal growth theory to "risk adjust" the relevant probabilities via weighting them by marginal utilities. Numerical reality-based examples will be presented showing that risk-adjusted discount rates could be surprisingly low. C: Finally, the two aspects of extreme climate change evaluation and long-term discounting will be integrated together into one unified model. This synthesis model will culminate in some numerical reality-based examples that will give extremely rough ballpark estimates of the combined e¤ects of uncertainty upon discounting and extreme climate change. 2: Broader Impacts The two topics of discounting the distant future and evaluation of fat-tailed extreme events are critical to the outcome of any economic analysis of climate change. The proposed line of research suggests an economic rationale for much lower distant-future discount rates and much heavier weighting of catastrophic outcomes. If successful, the research could have implications that go beyond economics. It might change the way that both climate-change economists and climate-change scientists view, separately and jointly, the controversial subjects of discounting the distant future and evaluating rare catastrophic events. In other words, there is some chance of bringing more closely together on the same page climate-change science and climate-change economics.