Discount Rate Set Too High

Slower economic growth highlights £2 trillion understatement of UK liabilities

• Author(s): Angus Hanton • Published: September 2012
• Pages in paper: 10


Abstract

The size of government liabilities is only now becoming apparent, but the choice of discount rate is crucial in estimating these. Historically this has been set using Green Book methods and FRS17 accounting standards, but now government is moving to using a rate based on hoped-for economic growth of 3% plus inflation. The more prudent rate to use would be the much lower gilt rate of under 1% – the government’s long-term index-linked cost of borrowing. Use of the 1% rate would show liabilities more than £2 trillion higher, and these will increase as the effects of using the higher discount rate ‘unwind’. Furthermore, the overoptimism from using a high discount rate can lead to poor policy decisions in pensions, government spending and strategic planning.



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What is Britain worth to the next generation?
Author: Angus Hanton

Government economic policy implicitly aims to build up useful reserves for future generations, or at least to not burden our children and grandchildren with unsustainable debt. Surprisingly, even though this must be an important policy objective, it is rarely discussed or measured. This paper estimates what Britain is now worth to the next generation and we explain how well recent British governments have done in building up value to hand on. The results are eye-watering for anyone who has assumed that there has been a steady build-up of wealth.

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