Macroeconomic Outcomes in Disaster-Prone Countries

Abstract

Using a dynamic stochastic general equilibrium model, we study the channels through which natural disaster shocks affect macroeconomic outcomes and welfare in disaster-prone countries. We solve the model using Taylor projection, a solution method that is shown to deal effectively with high-impact weather shocks calibrated in accordance to empirical evidence. We find large and persistent effects of weather shocks that significantly impact the income convergence path of disaster-prone countries. Relative to non-disaster-prone countries, on average, these shocks cause a welfare loss equivalent to a permanent fall in consumption of 1.6 percent. Welfare gains to countries that self-finance investments in resilient public infrastructure are found to be negligible, and international aid has to be sizable to achieve significant welfare gains. In addition, it is more cost-effective for donors to contribute to the financing of resilience before the realization of disasters, rather than disbursing aid after their realization.

Feeling the heat: Climate risks and the cost of sovereign borrowing

“…For example, Koetsier (2017) finds a considerable increase in government debt for most damaging and deadliest disasters. While a growing body of research has studied the macroeconomic impacts of climate change (Hochrainer 2009;von Peter, von Dahlen, and Saxena 2012;Cabezon et al 2015;Batten 2018;Mercure et al 2018;Cantelmo, Melina, and Papageorgiou 2019;Batten, Sowerbutts, and Tanaka 2020), relatively little research has been conducted on the nexus between climate risk and sovereign risk. That said, recent research by Kling et al (2018) on the relationship between climate vulnerability, sovereign credit profiles, and the cost of capital in climate-vulnerable developing countries shows that these countries incur a risk premium on their sovereign debt, reducing their fiscal capacity for investments in climate adaptation and resilience.…”

The Impacts of Disaster Risk on Sovereign Asset and Liability Management

“…When combining instruments,prearranged financing is key, whether this finance is domestic or from the international donor community. Both Cantelmo, Melina, and Papageorgiou (2019) and Marto, Papageorgiou, and Kluyev (2018) find that it is more cost-effective for donors to contribute to the financing of resilience before a disaster than to disburse aid afterward. They also find, however, that welfare gains to countries that self-finance investments in resilient public infrastructure are negligible, and international aid must be sizable to alter this.…”

Rare Disasters, the Natural Interest Rate and Monetary Policy

“…IPCC 2014;Alfieri et al, 2015;IMF, 2017). 3 As regards the economic impact of natural disasters related to climate change, Burke et al (2015), IMF (2017), Nordhaus (2019) and Cantelmo et al (2019) provide evidence of large and nonlinear effects. 4 However, it is still uncertain whether natural disasters entail prevalent demand-or supply-side effects whereby understanding which one prevails is paramount for the conduct of monetary policy.…”

“…Gourio et al (2018) investigate whether a leaning against the wind policy is optimal to reduce the probability of recurring financial crises. Cantelmo et al (2019) assess the combination of the ex-ante and the ex-post effects on the development path of small countries exposed to natural disasters using a calibrated small open economy RBC model and find much worse macroeconomic outcomes relative to developing countries less prone to natural disasters.…”

“…Similarly, IMF (2017) estimate that most of natural disasters will more than double their frequency in advanced and emerging economies by 2100, especially tropical cyclones and heat waves.4 For instance,Burke et al (2015) estimate that once a country passes a threshold of 13 • C, it starts losing more than proportionally on its GDP as temperature increases. Moreover,Cantelmo et al (2019) show that developing countries prone to natural disasters suffer much worse macroeconomic consequences than developing countries less exposed to them.5 Related to the recent Covid-19 shock,Guerrieri et al (2020) investigate the response of the natural rate exactly for this purpose. The framework used here can be also applied to study the effects of the Covid-19 pandemic as well as its implications for the transmission of monetary policy.…”