Maxim_Lott

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Against Discount Rates

I think there are many serious theoretical errors in this post.

When we say that the interest rate is 5%, that means that in general people would trade $1.05 next year for $1 today. It's basically a fact that they would be willing to do that - if people's real discount rate were lower, they would lend money to the future at a lower interest rate. Eliezer finds it absurd that it's 5% more important to give clean water to a family today than tomorrow, but how is it absurd when this is what consumers are saying they want for themselves as well. It's revealed preference.

That stat and the Bruno one are also misleading because:

1) 5% is too high because it is the nominal interest rate, not the real one.

The first reason why the Giordano Bruno number is misleading is that most of that interest rate is due to inflation. Current inflation is around 3%... so that leaves about 2% of the interest rate that is due to default risk and the inconvenience of having the money tied up. Historically, inflation was probably much higher and the actual return on investment may have been closer to zero percent. It's fine to use the nominal interest rate if we're comparing dollars today to dollars tomorrow, but lives and clean drinking water don't inflate like dollars do (so the interest rate on lives, so to speak, should not include that factor.)

2) "Default risk" is huge. Looking at history in retrospect is unfair.

Looking at things from the perspective of someone in Rome during 1600, a dollar could legitimately have been worth tens of thousands of times more than a promised dollar today. Rome could have been invaded in that time, the cold war could have gone nuclear, your investment company could simply have gone bankrupt or swindled you, etc. In fact, would an investment in Rome made in 1600 still be redeemable today? Would it really survive the period in Italian history labeled on wikipedia as "Foreign domination and unification (16th to 19th c.)" and Mussolini?

Any thoughts?