Natural disasters impacting a macroeconomic model with endogenous dynamics

We investigate the macroeconomic response to natural disasters by using an endogenous business cycle (EnBC) model in which cyclical behavior arises from the investment-profit instability. Our model exhibits a larger response to natural disasters during expansions than during recessions. This apparently paradoxical result can be traced to the disasters amplifying pre-existing disequilibria during expansions, while the existence of unused resources during recessions damps the exogenous shocks. It thus appears that high-growth periods are also highly vulnerable to supply-side shocks. In our EnBC model, the average production loss due to a set of disasters distributed at random in time is highly sensitive to the dynamical characteristics of the impacted economy. Larger economic flexibility allows for a more efficient and rapid response to supply-side shocks and reduces production losses. on the other hand, too high a flexibility can lead to vulnerability phases that cause average production losses to soar. These results raise questions about the assessment of climate change damages or natural disaster losses that are based purely on long-term growth models. (c) 2008 Elsevier B.V. All rights reserved.