Macroeconomic and Financial Impacts of Compounding Pandemics and Climate Risks

48 Pages Posted: 19 Apr 2021 Last revised: 7 Jun 2021

See all articles by Nepomuk Dunz

Nepomuk Dunz

World Bank

Andrea Mazzocchetti

Ca Foscari University of Venice

Irene Monasterolo

Utrecht University

Arthur Hrast Essenfelder

Ca Foscari University of Venice

Marco Raberto

Università degli Studi di Genova - DIME - Department of Mechanics, Energetics, Management and Transportation

Date Written: April 16, 2021

Abstract

Climate risks often do not happen in isolation but can compound with other sources of stress such as pandemics and pre-existing financial vulnerabilities, particularly in emerging countries. Compounding events increase the complexity of risk, leading to cascading impacts in the economy and finance. Thus, tailoring macroeconomic models to include compound risk considerations can inform effective recovery policies, avoiding to underestimate risk. We build on the EIRIN macrofinancial model (Monasterolo & Raberto, 2018, 2019) to quantitatively assess the direct and indirect impacts of compound COVID-19 and climate physical risks in the economy and finance, accounting for the fiscal and monetary policy response to shocks. EIRIN captures the richness of climate risk transmission to the economy and finance in a rigorous accounting framework. In addition, EIRIN explicitly embeds a financial sector and financial market, thereby allowing the analysis of the impact of financial feedbacks on endogenous investment and consumption decisions, and on policy effectiveness. Then, via a compound risk indicator, we quantify the non-linearity of compound risk on GDP through time. We calibrate the model on Mexico, a country that is highly exposed to hurricane hazard and COVID-19, and deeply integrated in the global value chain, representing a potential channel of cascading risks. We show that compounding climate physical and COVID-19 risk can give rise to non-linear dynamics that amplify losses, with implications on private and public debt sustainability. The initial shocks’ magnitude and their specific risk transmission channels contribute to explain the evolution of compound risks, given the country’s pre-shock characteristics. Credit market constraints can amplify the shock by limiting firms’ recovery investments, thus mining the effectiveness of increasing fiscal spending. Fiscal policies that depart from a business as usual recovery, and align to climate objectives, could help to build resilience to compound risk, avoiding increases in countries’ divergence and debt sustainability challenges.

Keywords: Climate physical risk, COVID-19, compound risk, credit market constraints, public spending effectiveness, debt sustainability

JEL Classification: E4, Q07, G01

Suggested Citation

Dunz, Nepomuk and Mazzocchetti, Andrea and Monasterolo, Irene and Hrast Essenfelder, Arthur and Raberto, Marco, Macroeconomic and Financial Impacts of Compounding Pandemics and Climate Risks (April 16, 2021). Available at SSRN: https://ssrn.com/abstract=3827853 or http://dx.doi.org/10.2139/ssrn.3827853

Nepomuk Dunz

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Andrea Mazzocchetti

Ca Foscari University of Venice ( email )

Irene Monasterolo (Contact Author)

Utrecht University ( email )

Vredenburg 138
Utrecht, 3511 BG
Netherlands

Arthur Hrast Essenfelder

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Marco Raberto

Università degli Studi di Genova - DIME - Department of Mechanics, Energetics, Management and Transportation ( email )

Via Opera Pia 15
Genova
Italy

HOME PAGE: http://www.dime.unige.it/en/user/120

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
416
Abstract Views
1,899
Rank
134,891
PlumX Metrics