Temperature shocks and welfare costs

Abstract

This paper examines the welfare implications of rising temperatures. Using a standard VAR, we empirically show that a temperature shock has a sizable, negative and statistically significant impact on TFP, output, and labor productivity. We rationalize these findings within a production economy featuring long-run temperature risk. In the model, macro-aggregates drop in response to a temperature shock, consistent with the novel evidence in the data. Such adverse effects are long-lasting. Over a 50-year horizon, a one-standard deviation temperature shock lowers both cumulative output and labor productivity growth by 1.4 percentage points. Based on the model, we also show that temperature risk is associated with non-negligible welfare costs which amount to 18.4% of the agent's lifetime utility and grow exponentially with the size of the impact of temperature on TFP. Finally, we show that faster adaptation to temperature shocks results in lower welfare costs. These welfare benefits become substantially higher in the presence of permanent improvements in the speed of adaptation.JEL classification: E30, G12, Q0

Can Variations in Temperature Explain the Systemic Risk of European Firms?

“…Letta and Tol (2018) find a strongly negative relationship between total factor productivity and temperature. Donadelli et al (2017b) support that temperature shifts have a long run negative effect on labour productivity. Hsiang (2010) finds that increasing temperature by 1 • C can have negative effect of 2.4% on labour productivity.…”

“…A possible explanation has been given by labour productivity scholars. In particular, Hsiang (2010), Donadelli et al (2017b), Letta and Tol (2018) underscore that temperature and productivity are negatively related and this could potentially lead to financial turmoil, considering that their interaction might change the components of aggregate supply and demand (ESRB Advisory Scientific Committee 2016; Dafermos et al 2017). In close relation to this, Weagley (2018) supports that extreme temperatures would increase the energy demand and consequently increase operational cost for firms.…”

“…As far as the motivation of our study is concerned, it should be noted that in this paper, we combine knowledge from (1) the effects of temperature on stock markets and (2) the broader systemic risk literature. The first strand of the literature concentrates mainly on how temperature innovations influence stock market returns (e.g., Cao and Wei 2005;Bansal and Ochoa 2011;Novy-Marx 2014;Donadelli et al 2017b;Balvers et al 2017). This strand has mainly identified that temperature has macroeconomic risk characteristics that affect stock market returns.…”

Climate Impacts on Capital Accumulation in the Small Island State of Barbados

“…The motivation for this covariate is that tropical storm intensity tends to rise with sea surface temperature [54], although not uniformly, because temperature and pressure in the atmosphere also affect the intensity of storms [55]. Localized temperature extremes can also impact economic performance [18,56], but here our focus is on temperature averaged over large areas as a covariate with storm intensity.…”

“…It is applied to a national scale but could also be applied to a regional scale. The economic sub-model is structuralist [5,16,17], which makes it similar to the post-Keynesian model by Rezai et al [10], but different from, for example, the DSGE model presented in [18] or the neoclassical FUND and DICE models. The goal for the climate damage sub-model is to represent the loss of productive capital through extreme climate events, whereby, "productive capital" represents the physical stocks used to produce goods and services for sale, as opposed to non-commercial capital, non-productive commercial capital (such as protective structures) and public infrastructure.We depart from both FUND and DICE by proposing a behaviorally-motivated model for climate damage, rather than a parameterized model.…”