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Rare disasters, the natural interest rate and monetary policy

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  • Alessandro Cantelmo

    (Bank of Italy)

Abstract

This paper evaluates the impact of rare disasters on the natural interest rate and macroeconomic conditions by simulating a nonlinear New-Keynesian model. The model is calibrated using data on natural disasters in OECD countries. From an ex-ante perspective, disaster risk behaves as a negative demand shock and lowers the natural rate and inflation, even if disasters hit only the supply side of the economy. These effects become larger and nonlinear if extreme natural disasters become more frequent, a scenario compatible with climate change projections. From an ex-post perspective, a disaster realization leads to temporarily higher natural rate and inflation if supply-side effects prevail. If agents' risk aversion increases temporarily, disasters may generate larger demand effects and lead to a lower natural rate and inflation. If supply-side effects dominate, the central bank could mitigate output losses at the cost of temporarily higher inflation in the short run. Conversely, under strict inflation targeting, inflation is stabilized at the cost of larger output losses.

Suggested Citation

  • Alessandro Cantelmo, 2020. "Rare disasters, the natural interest rate and monetary policy," Temi di discussione (Economic working papers) 1309, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1309_20
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    File URL: https://www.bancaditalia.it/pubblicazioni/temi-discussione/2020/2020-1309/en_tema_1309.pdf
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    1. Rare disasters, the natural interest rate and monetary policy
      by Christian Zimmermann in NEP-DGE blog on 2021-01-13 18:04:03

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    More about this item

    Keywords

    rare disasters; natural disasters; natural interest rate; climate change; DSGE; monetary policy;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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