Dual-rate discounting in dynamic economic-environmental modeling

Discounting plays a crucial role in the economic-environmental modeling with long time horizons. The models with conventional uniform discounting run into difficulties in justifying the cost-benefit tradeoffs of some environmental policies, such as the Kyoto Protocol for greenhouse gas emission reductions. In this paper, we propose a dichotomized approach to resolve the difficulties. Specifically, we suggest that the dual-rate discounting be used in economic-environmental modeling. In such a model, private investments are guided by a conventional discount rate and the environmental investments are guided by a much lower 'environmental' discount rate. The dual-rate intertemporal decisions coexist in a time-consistent dynamic system. To validate the notion of dual-rate discounting, we implement it in the regional integrated model of climate and economy model (Am. Econ. Rev. 86 (1996) 741) through an iterative algorithm. The results from the model simulation confirm the desirable properties of dual-rate discounting.