ANSWERING THE SOCIAL DISCOUNT RATE QUESTION

Discounting project net flows with prescriptive rates fails to reflect costs of capital; discounting them with descriptive rates fails to reflect intertemporal preferences. A two-rate discounting method is proposed by which descriptive rates are used to forecast costs of capital and prescriptive rates are used to discount all-inclusive net welfare flows. This solves the long-standing social discount-rate dilemma because it satisfies in full the requirements of both approaches and measures the welfare impact of projects accurately. For projects to be economically feasible their internal rate of return should exceed both the social time preference rate (STPR) and the social opportunity cost rate (SOCR). Following this rule will ensure that proposed public sector projects will be no less effective at converting present consumption into future consumption than what the public can already manage and that the benefits of proposed projects will exceed all their direct and indirect costs. An agent-based capital market model with multiple actors and two financial instruments, one of them stochastic, audits the performance of alternative discounting methods. <br><br><br><br><br>