Climate Disasters and the Macroeconomy: Does State-Dependence Matter? Evidence for the US

Global climate is changing, and the occurrence of climate disasters has been rising. There is growing concern that climate change is expected to increase the frequency and intensity of weather events. Yet, the consequential effects of disasters and the ensuing implications of policymakers’ responses remain unclear. While the majority of research on climate change is ex ante, this paper explores the ex post transmission of disaster damages on economic conditions. In doing so may offer a glimpse of key, future policy options around how a disaster shock influences economic conditions, not only with regards to how a disaster affects output, as in the existing research, but also to aid policy makers and the public to further understand the influences on inflation, interest rate and economic policy uncertainty (EPU). Using a multivariate regression, we find that the impact of a natural disaster on EPU is positive and statistically significant during an expansionary phase while controlling for other determinants. Using a non-linear VAR model with local projections (LP), the aftermath of a disaster is estimated to marginally decrease output and increase inflation during an expansionary state. Accordingly, the empirical findings suggest the interest rate set by the U.S. Federal Reserve (Fed) remains relatively unchanged to a disaster shock, which is operating in a manner that is proportional to the magnitude of change in output and inflation. Consistent with the multivariate regression model, the VAR-LP demonstrates that the impact of a natural disaster magnifies the increase in EPU during periods of economic expansion.