A precarious globe balanced on interest rate graphs, representing the challenges of climate finance.

Climate Mitigation's Hidden Costs: Why Interest Rates Matter More Than You Think

Samir D’Costa in Climate & Environment August 2025 • 4 min read.

"Uncover the surprising ways stochastic interest rates can undermine climate action and how innovative financing can build a more equitable future."

The urgency of climate change demands immediate and effective action. Today’s decisions about emissions reductions and sustainable practices will profoundly impact the well-being of future generations. One of the most critical, yet often overlooked, components of climate change mitigation is the role of interest rates. Discounting future benefits and costs is central to creating efficient climate mitigation pathways.

Integrated assessment models (IAMs) like the Dynamic Integrated Climate-Economy (DICE) model help economists and policymakers model climate strategy. However, traditional models often treat discount rates as static, which can hide significant intergenerational consequences. A groundbreaking study extends the DICE model by incorporating stochastic discount rates to reflect the inherent uncertainty in financial markets.

This article explores how stochastic interest rates affect climate mitigation strategies, revealing potential inequalities and exploring innovative financing mechanisms to promote a more equitable distribution of climate action costs. Learn how a deeper understanding of interest rates can lead to more effective and just climate policies.

The Unequal Burden: How Stochastic Interest Rates Amplify Intergenerational Inequality

A precarious globe balanced on interest rate graphs, representing the challenges of climate finance.

Traditional climate models often assume a fixed discount rate, but the real world is far more complex. Interest rates fluctuate constantly, influencing the economic viability of long-term climate projects. When these fluctuations are factored into climate models, the results can be unsettling. The research reveals that optimization procedures within the DICE model tend to induce intergenerational inequality. Without mechanisms to regulate burden-sharing, future generations bear disproportionately higher costs related to both abatement and damage relative to their GDP.

Adding uncertainty about discount rates, which influences abatement policies, creates even larger inequality. This can be interpreted as a successive recalculation of the costs and benefits, which causes skewed risks. This inequality arises because the standard optimization process doesn’t equalize the burden across generations, instead focusing on a weighted marginal burden. This approach is indifferent to the distribution of absolute costs, leading to potentially unfair outcomes.

Stochastic Discount Rates: Traditional models use fixed rates, creating a false sense of certainty.
Intergenerational Imbalance: Future generations shoulder a heavier economic load.
Optimization Shortcomings: Current models fail to ensure fair cost distribution.

Imagine a scenario where today's investments in renewable energy seem less appealing due to rising interest rates. As a result, current generations might delay action, leaving future generations to face steeper emissions cuts and greater climate damages. The study highlights a critical flaw in how we assess climate policies. Standard models might inadvertently exacerbate inequalities if uncertainty isn't factored into those climate strategies.

Financing a Fairer Future: Innovative Solutions for Climate Mitigation

The study offers a solution: Additional financing mechanisms can promote intergenerational effort sharing. By allowing the funding of abatement costs and considering non-linear financing effects for large damages, the burden can be more evenly distributed. For example, dedicating a portion of current GDP to climate investments can ensure future generations aren't saddled with insurmountable costs. Researchers propose modifying optimization models to keep costs below 3% of GDP. It results in a more equal distribution of efforts between generations. We can pave the way for climate mitigation that is effective, economically sound, and, most importantly, fair.

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2312.07614,

Title: Intergenerational Equitable Climate Change Mitigation: Negative Effects Of Stochastic Interest Rates; Positive Effects Of Financing

Subject: q-fin.mf econ.gn q-fin.ec

Authors: Christian P. Fries, Lennart Quante

Published: 11-12-2023

Everything You Need To Know

Why are stochastic interest rates important when considering climate mitigation strategies?

Stochastic interest rates are crucial because they reflect the real-world uncertainty in financial markets, unlike traditional models that use fixed discount rates. By incorporating these fluctuating rates into models like the Dynamic Integrated Climate-Economy (DICE) model, we can better understand the potential intergenerational inequalities that arise from climate policies. Ignoring these fluctuations can lead to unfair cost distributions, where future generations bear a disproportionately higher economic burden.

How do traditional climate models, like the DICE model, fall short in addressing intergenerational equity in climate mitigation?

Traditional climate models, particularly the Dynamic Integrated Climate-Economy (DICE) model, often use static discount rates, which don't account for the variability in financial markets. This can lead to optimization processes that induce intergenerational inequality, as these models don't equalize the burden across generations. They focus on a weighted marginal burden, potentially resulting in future generations facing steeper emissions cuts and greater climate damages without sufficient economic support from current actions.

What specific mechanisms can be implemented to finance a fairer distribution of climate action costs between generations?

To promote intergenerational effort sharing, additional financing mechanisms are essential. One approach involves dedicating a portion of current Gross Domestic Product (GDP) to climate investments, ensuring that future generations are not saddled with insurmountable costs. Modifying optimization models to keep costs below a certain percentage of GDP, such as 3%, can also lead to a more equitable distribution of efforts between generations. These strategies address the shortcomings of models like the Dynamic Integrated Climate-Economy (DICE) model which tends to induce intergenerational inequality.

What are the potential consequences of ignoring stochastic discount rates in climate policy decision-making?

Ignoring stochastic discount rates can have significant consequences, primarily exacerbating intergenerational inequalities. Rising interest rates may make current investments in renewable energy seem less appealing, leading to delayed action on emissions reductions. As a result, future generations may face more severe climate damages and the need for steeper, more costly emissions cuts. Standard models that don't account for uncertainty can inadvertently lead to unfair outcomes, undermining the effectiveness and fairness of climate policies derived from models such as the Dynamic Integrated Climate-Economy (DICE) model.

How do optimization procedures within integrated assessment models, such as the DICE model, contribute to intergenerational inequality in climate mitigation efforts?

Optimization procedures within integrated assessment models, like the Dynamic Integrated Climate-Economy (DICE) model, can contribute to intergenerational inequality because they often focus on a weighted marginal burden without considering the distribution of absolute costs across generations. This approach can be indifferent to how the economic burden is shared, leading to potentially unfair outcomes where future generations bear disproportionately higher costs related to both abatement and climate damages. The standard optimization process doesn’t equalize the burden across generations.