Discounting and the Time Preference Rate

Abstract

This paper provides an analytical review of the evaluation of alternative time streams of consumption and the closely related concept of time preference. The potential sensitivity of comparisons, especially to the choice of time preference rate and elasticity of marginal valuation, is demonstrated. The nature of time preference, based on an axiomatic approach, is then discussed. The analysis of optimisation over time leads to the concept of the social time preference rate, and a difficulty with using this rate is highlighted. Approaches giving rise to declining discount rates over time are discussed, including alternative welfare functions and the role of uncertainty. This is followed by a critique of methods used to 'estimate' a time preference rate. Finally, complications introduced by non-income differences between individuals are examined. Emphasis is placed on the central role of value judgements.