Making the implicit explicit: A look inside the implicit discount rate

TLDR

Implicit discount rates are used in energy models to represent household investment in energy‑efficient technologies, but their underlying drivers are unclear and high rates alone do not inform policy. The study proposes a framework that categorizes the drivers of implicit discount rates into preferences, predictable (ir)rational behavior, and external barriers to energy efficiency. The framework delineates which factors can be modified through policy interventions and which are inherent, guiding how to incorporate them into models. Empirical evidence indicates that IDR drivers vary by household and technology, and the framework provides a new perspective on how these drivers interact with policy.

Abstract

Implicit discount rates (IDRs) are employed in energy models to capture household investment decisions, yet the factors behind the IDR and their respective implications for policy-making usually remain blurred and fractional. The proposed comprehensive framework distinguishes three broad categories of factors underlying the IDR for household adoption of energy-efficient technologies (EETs): preferences (notably over time, risk, loss, debt, and the environment), predictable (ir)rational behavior (bounded rationality, rational inattention, behavioral biases), and external barriers to energy efficiency. Existing empirical findings suggest that the factors underlying the IDRs that differ across household characteristics and technologies should be accounted for in energy models. Furthermore, the framework allows for a fresh look at the interplay of IDRs and policies. We argue that a simple observation of high IDRs (or observing correlations between IDRs and socio-economic characteristics) does not provide guidance for policy-making since the underlying sources cannot be identified. Instead, we propose that some of the factors underlying the IDR - notably external barriers - can be changed (through directed policy interventions) whereas other factors - notably preferences and predictable (ir)rational behavior - are innate and can only be taken into account (through reactive policy interventions).