Natural Disasters and Fiscal Procyclicality

This paper examines how climate-related natural disasters influence the cyclical stance of fiscal policy across 148 countries between 1980 and 2023. Using a dynamic panel System-GMM framework, we document that while fiscal policy has become increasingly countercyclical in many economies, extreme natural disasters systematically reverse this trend, pushing fiscal behavior toward greater procyclicality. The analysis shows that the magnitude of disaster damage, rather than the frequency of events, is the key determinant of this shift. Severe events, defined by high economic losses or large affected populations, significantly strengthen the positive correlation between government spending and the output gap, with effects that grow non-linearly at higher damage levels. We also evaluate mechanisms that can mitigate these dynamics. Greater insurance coverage and higher climate-readiness modestly attenuate disaster-induced procyclicality, while fiscal rules exert the strongest protective effect, rendering fiscal responses acyclical or countercyclical even after extreme shocks. Results are robust across alternative filters for cyclical components and standard diagnostic tests. Overall, the paper highlights the need for climate-aware fiscal frameworks anchored in credible rules, financial preparedness, and adaptive capacity, to preserve stabilization space as natural disasters become more frequent and severe.