Discount rates are used to compare current and future costs. Confusion sometimes arises because of the failure to distinguish between a discount rate and a discount factor. To illustrate the difference, suppose you have a government savings bond that will be worth $1,000 next year. Because you need the money today, you sell the bond and only get $935. The discount factor is 935/1000 or 0.935. If you waited till next year, you would get the remaining $65. Your rate of return on holding the bond another year would thus be 65/935, which is 7%. That is the discount rate.

With a discount factor of 0.935, anything in the far-off future has a minuscule present value. For instance, if you multiply 0.935 by itself a hundred times, the answer is only 0.001. The implication is that $1,000 of climate damages a hundred years from now is worth only $1 today. If a dollar spent on climate investments today would offset less than $1,000 of damages a century ahead, it would make more sense to invest in the stock market, assuming the market keeps earning the average 7% return it has in the past. A $1 investment in stocks at that rate of return would give your heirs $1,000 in a hundred years.

As the historical average real rate of return on the stock market, 7% represents the average rate of return on private sector investments in the economy.