Flooded House or Underwater Mortgage? The Macrofinancial Implications of Climate Change and Adaptation

Abstract

I study the macrofinancial implications of climate change and private adaptation. Households are exposed to extreme weather events, which damage housing and degrade land which is in inelastic supply. While the exposure to climate risk weakens demand for housing, I show that the materialization of climate change raises house prices, as habitat becomes increasingly scarcer. This leads to a reallocation of credit in the economy towards households. In frictionless markets, price signals lead to efficient adaptation. However, credit-constrained households have weaker incentives to adapt to climate change, indicating that pricing alone may be insufficient. Unequal adaptation reinforces wealth inequality and leads to a further reduction in future habitat. Since this increases the importance of housing relative to future consumption, the private adaptation gap widens over time. I show that a societal shift from constrained homeownership to a rental model with unconstrained owners could lead to more efficient adaptation.

Keywords: Climate Change, Climate Change Adaptation, Housing, Financial Assets, Financial Constraints, Extreme Weather Events, Wealth Inequality

JEL Classification: E44, G51, Q54