Discount rates

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The Discount Rate: How Much Should the Government Charge in Interest Last Updated on 2010-12-18 00:00:00 Banks lend money at interest rates that incorporate the risk of nonpayment, the rate of inflation, and a decent rate of return on investment. In contrast, government borrowing carries a low risk of nonpayment. Consequently, to convert values of future costs or benefits to present ones, governments use a different rate, most commonly called the discount rate, which depends primarily on the rate of return on investment. What constitutes a decent rate of return on investment and thus an appropriate discount rate? Several processes come into play. First, there is the impatience principle, whereby people expect some compensation if they must wait for something. A second process is the marginal productivity of capital, the extent to which an extra dollar invested in resources today produces more than a dollar’s worth of additional goods or services in the future. For example,... More »