ABSTRACT
The radical proposition of Arrow and Lind (1970) – that governments should use risk-free rates instead of market rates to discount their risky investments – can best be understood by first considering the work in its historical context.1 During the late 1960s and early 1970s, a debate was raging between the leading economists of the time about the cost of risk to the government, and related, the identification of the social discount rate. Recent advances in general equilibrium theory (notably, Arrow & Debreu, 1954; Debreu, 1959) allowed for more general welfare analyses of policy than had been undertaken previously; underscored the benefits of risk-sharing as well as the aggregate limits on risk-sharing; and clarified the role of market prices in aggregating the risk preferences of society. Such analyses also highlighted the potentially salutary role for governments in improving risksharing when markets are incomplete.
