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<br />THE "PROPER" DISCOUNT RATE <br /> <br />Much debate has centered on the quastion of what is the <br /> <br />"proper" discount rate to use in considering future benefits of <br /> <br />government projects. The Bureau of Reclamation used 3.250 ?ercent <br />on their May, 1977 estimates of the benefit-tost ratios. However, <br />there is increasing argument, especially from the Office of Manage- <br />ment and Budget (OMB) and other executive and legislative agencies, <br /> <br />that, in light of current interest rates, a higher discount rate <br /> <br />should be used. These agenciea have focused on 6.625 percent. <br /> <br />J <br /> <br />~~ ! <br /> <br />There are two serious errors in using a higher discount rate <br /> <br />( <br /> <br />because it is more "realistic": <br /> <br />1. Interest rates have always varied over time and hava <br /> <br />always been higher during periods of inflation. People <br /> <br />i <br /> <br />will not lend money unless there is some "real" return .- <br /> <br />that is, unless there is some "inflationary premium" added <br /> <br />to the real rate of interest. This fact is aptly <br />illu$trated in Chart 1. <br /> <br />"," <br /> <br />During periods of inflation, the nominal rate of interest <br /> <br />,., <br />t'_, <br /> <br />'- ; <br /> <br />tends to be much higher than the real rate. Obviously, since <br /> <br />;~ <br />",', <br /> <br />long term government rates (since 1900) were (for most <br /> <br />i'-' <br /> <br />decadas) even less than the 3.250 percent used in the initiel <br /> <br />estimate perhaps even a discount rate of less than the 3.250 <br /> <br />percent should be used. <br /> <br />26 <br />