1. Social Discount Rate in an Era of Low Interest Rates and Weak Private Investment
Nikitas Pittis
University of Piraeus, ICRE8
Third SDSN Mediterranean Conference
September 7-8, 2017 Athens Greece

2. Time of Project Evaluation Discounting: At which Rate?
Τhe larger the discount rate, the smaller the present value of a future amount
Benefit - Cost
Benefit - Cost
Benefit - Cost $1 $2 $3
t = 0
t = 1
t = 2
t = 3
time
Discounting:
convert costs and benefits that occur in the future into the equivalent values they would have if realized today today.
Discounting
Discounting
Discounting: At which Rate?
Discounting

3. Social Discount Rate: Main Issues
SDR
Not Analyzed Here
How Should it be Related to Market Rates?
Constant or Declining Over Time?
Market Rates are at Historically Low Levels Globally
A Big Disconnect between Investors’ Willingness to Assume Financial over Economic Risk
Compressed Financial Risk Premia Combined with Weak Private Investments

4. SDR: Two Competing Interpretations
Two Discount Rates
Social Opportunity Cost
Social Rate of Time Preference
Determinants?
Risk Premium
Savers’ willingness to substitute present for future consumption
Account for Investment Risk
SRTP ≤ SDR ≤ SOC

5. Empirical Measures of SRTP (For example, Current guidance from the Office of Management and Budget - last revised in 2003, Circular A4):
SRTP ~ Long-term (10-Year) Real Government Bond Yield
: Average Nominal 10Y Yield = 8.1%
: Average Inflation Rate = 5%
Hence, Real Rate = 8.1%-5% = 3.1%

6. Empirical Measures of SOC
SOC = SRTP + Risk Premium
Risk Premium is the Extra (Excess) Return that An Investor Requires – over and above Risk Free Rate – as a Compensation for the Risk of the Investment
Risk Premium is Unobservable
Estimates Vary Widely
OMB’s Estimate (2003) = 4%

7. The New Era: A Structural Shift
Global Interest Rates are at Historically Low Levels
Low for Long?
Current US Real 10Y Yield: 2.07% - 1.7% = 0.37%
Current GE Real 10y Yield: 0.35% - 1.8% = -1.45%

8. The Private Investment Paradox:
Personal Consumption: Annual Rate of Change
Business Investment: Annual Rate of Change
Despite the Extremely Lowe Rates, Business Investment has been Persistently Weak
REASONS?
Structural
Cyclical

9. Interest Rates: Low for Long?
Excess Savings from Emerging Markets – China:
Global Savings Glut
Decline in Potential Growth:
Low Productivity
Declining Labor Force growth
Reasons for Historically Low Rates
Ultra Accommodative Monetary Policy: QE
Unfavorable Demographics:
Ageing Population
Most of these Causes are Here to Stay
Anemic Demand for Business Investment:
Low Productivity Growth
Elevated Uncertainty
Disruptive Capacity of new Technologies – New Business Models?
Decrease in Competition within Industries
QE: Financial vs. Economic Risk

10. Risk Premia: Massively Compressed
SDR = Market Rate + Risk Premium
Risk Premia
The Risk that Investors are Willing to Assume to “Buy” one Unit of Expected Return has Surged

11. Implications for Government Projects
Supply of Funds is Far Greater than the Demand for Funds
Private Sector Seems to be Unwilling to Fully Utilize the Available Funds
Hence, Public Investments Do not Displace Private Ones (No Crowding Out)
Government Projects - especially those that relate to global climate change – May be Used as Instruments for Fiscal Expansion
Hopefully, they May Pave the Way for Private Investments related to Climate Change

12. Potential Impediment: Sovereign Debt
Germany is Better Positioned than US for Fiscal Expansion