Changes in Natural Disaster Risk: Macroeconomic Responses in Selected Latin American Countries

Abstract

This paper studies the theoretical effects of changes in disaster risk on macroeconomic variables in five Latin American economies. It compares country-specific variants of the New Keynesian model with disaster risk developed by Isoré and Szczerbowicz (2017). Countries with higher price flexibility, such as Argentina, Brazil, and Mexico, are found to be relatively less vulnerable to disaster risk shocks, as compared to Chile and Colombia in particular. Overall, the analysis suggests that increases in the probability of natural disasters over time may have significant macroeconomic effects, beyond the direct impact of actual disaster occurrences themselves.

Rare Disasters, the Natural Interest Rate and Monetary Policy*

“…Moreover, models of rare disasters (see e.g. Barro, 2006;Gabaix, 2012;Gourio, 2012 andIsoré andSzczerbowicz, 2017) introduce this type of shock to allow for partial defaults on government bonds, i.e. conditional on the realization of disasters, the stock of bonds is lower due to the default thus causing a drop in the price and an increase in the rate of return.…”

“…5 While the empirical evidence has not yet come to a consensus, I show how the monetary policy response depends on whether demand or supply forces prevail. Finally, ex-ante effects are studied by Isore and Szczerbowicz (2017) and Isore (2018) to show that disaster risk triggers a negative demand shock. In independent work, Dietrich, Muller, and Schoenle (2021) exploit survey data to calibrate the expectation of disasters in a model akin to the one studied here but only focus on the ex-ante dimension.…”

“…Isoré and Szczerbowicz (2017) set up a NK version of the RBC model of Gourio (2012) and show that disaster risk is essentially a negative demand shock, with falling inflation. Along these lines, Isoré (2018) shows that higher natural disaster risk in five Latin American countries can trigger a negative demand shock. However, they both focus only on the ex-ante effects of disasters and neglect the implications for the natural rate.…”

Rare Disasters, the Natural Interest Rate and Monetary Policy

“…Moreover, models of rare disasters (see e.g. Barro, 2006;Gabaix, 2012;Gourio, 2012 andIsoré andSzczerbowicz, 2017) introduce this type of shock to allow for partial defaults on government bonds, i.e. conditional on the realization of disasters, the stock of bonds is lower due to the default thus causing a drop in the price and an increase in the rate of return.…”

“…Isoré and Szczerbowicz (2017) set up a NK version of the RBC model of Gourio (2012) and show that disaster risk is essentially a negative demand shock, with falling inflation. Along these lines, Isoré (2018) shows that higher natural disaster risk in five Latin American countries can trigger a negative demand shock. However, they both focus only on the ex-ante effects of disasters and neglect the implications for the natural rate.…”