The nature of discounting

From monetary policies to the climate change problem, from the burden of private credit card debts to the evaluation of public projects, discount rate is the central issue, yet there is little clear understanding about the nature of discounting. In this paper, applying a newly developed production theory, we discuss how discount rate is related to other factors in social systems, such as risk, duration of production, fixed cost in production and market size. The relations among different factors in a social system put constraints on the ranges of discount rate that are viable in particular environments. Our findings have strong policy implications. In a world of increasing cost of extracting natural resources, the continuation of low discount rate policy will generate wide gyration of social systems that we have witnessed in recent years.

► We develop a new theory of discounting. ► Discount rate is related to other factors in social systems, such as risk, duration of production, fixed cost in production and the market size. ► The relations among different factors in a social system put constraints on the choice of discount rate. ► Discount rate should increase with the increasing cost of resources extraction, which will eventually limit the size of economy.