Discounting the Future: Stern vs Nordhaus

How the choice of discount rate shapes how much we should spend now to avoid climate damage in the future, and the famous debate between two economists.

Climate policy involves spending money now to avoid damage decades or centuries in the future. How should we compare costs today with benefits far in the future? Economists use discounting.

What discounting means

A discount rate converts future amounts into today’s value, called present value. At a 5 percent discount rate, 100 dollars in 50 years is worth only about 9 dollars today. At 1.4 percent, it is worth around 50 dollars. The higher the discount rate, the less future damage counts today.

The Stern-Nordhaus debate

Two influential economists reached different conclusions largely because of their discount rates.

Nicholas Stern, in his 2006 review, used a low discount rate, around 1.4 percent. He argued that it is ethically wrong to value future generations’ wellbeing less just because they live later. His analysis concluded that strong, early action to cut emissions was justified.
William Nordhaus, who later won the Nobel prize in 2018, used a higher discount rate based on observed market interest rates and returns on investment. His analysis supported a more gradual “policy ramp”, with carbon prices starting lower and rising over time.

Why it matters

The discount rate has two parts:

Pure time preference: valuing the present more simply because it comes first. Stern set this close to zero on ethical grounds.
Growth adjustment: if future people will be richer, an extra dollar matters less to them, so future damages count somewhat less.

Choices about these parts are partly ethical, not just technical. Economists continue to debate them, and some argue for discount rates that decline over very long time horizons.

The same damage, different values

Suppose climate change causes 1 trillion dollars of damage in 100 years. At a 1 percent discount rate, its present value is about 370 billion dollars, justifying large spending today. At a 5 percent rate, its present value is under 8 billion dollars, justifying much less. The same future damage looks enormous or small depending on the discount rate.

Thinking the discount rate is a purely technical detail

The discount rate involves ethical judgements about how much we care about future generations. Different reasonable choices lead to very different policy recommendations.

Key takeaways

Discounting converts future costs and benefits into today's value.
Stern used a low discount rate and recommended strong early action.
Nordhaus used a higher, market-based rate and recommended a gradual policy ramp.
Discount rate choices involve ethical judgements about future generations.