Temperature Shocks and Welfare Costs

49 Pages Posted: 7 Aug 2017

See all articles by Michael Donadelli

Michael Donadelli

Leibniz Institute for Financial Research SAFE

Marcus Jüppner

Leibniz Institute for Financial Research SAFE; Deutsche Bundesbank

Max Riedel

Leibniz Institute for Financial Research SAFE

Christian Schlag

Goethe University Frankfurt; Leibniz Institute for Financial Research SAFE

Date Written: August 4, 2017

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.

Keywords: Temperature shocks, long-run growth, asset prices, welfare costs, adaptation

JEL Classification: E30, G12, Q0

Suggested Citation

Donadelli, Michael and Jüppner, Marcus and Riedel, Max and Schlag, Christian, Temperature Shocks and Welfare Costs (August 4, 2017). SAFE Working Paper No. 177, Available at SSRN: https://ssrn.com/abstract=3013537 or http://dx.doi.org/10.2139/ssrn.3013537

Michael Donadelli

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Marcus Jüppner

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Strasse 14
60431 Frankfurt am Main
Germany

Max Riedel

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Christian Schlag (Contact Author)

Goethe University Frankfurt ( email )

Faculty of Economics and Business
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

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