A New Look at the Effects of Weather Shocks Over Time

This article examines the relationship between severe weather shocks and the U.S. macroeconomy from 1963 to 2019, applying a novel empirical approach to high-frequency data. We find weather shocks are growing in their influence on key economic variables, such as industrial output, unemployment and inflation.

The dynamics between the weather — and the natural environs more generally — and our economy are complex. Has this multifaceted relationship evolved over time?

There is reason to think that the relationship between weather events and economic activity will not remain static. Our actions alter the climate, and climate and weather events alter economic decision-making, such as decisions to build in coastal areas, for instance.

My recent working paper "Severe Weather and the Macroeconomy" — co-authored with Christian Matthes and Hee Soo Kim, both of Indiana University — employs an advanced econometric model, known as the smooth transition vector autoregression, to examine the ever-changing relationship between weather patterns and economic adjustments in a more flexible manner than previous approaches.

To be clear, this is a statistical model of the relationship between weather patterns and economic activity. As such, we can think of this model as a time machine, as it lets us explore how the relationship between the economy and the weather has transformed over time. Instead of just dissecting the data into smaller subsets (which might overlook intriguing fluctuations), we analyze the entire range of available information, enabling a comprehensive and detailed understanding.

Employing this econometric model, we embark on a trip into the past, analyzing U.S. economic data for the period between 1963 and 2019 (capturing the period before the pandemic). Our companions in this exploration are both standard economic data and a new meteorological time series for severe weather developed by actuary associations as a monitoring tool: the Actuaries Climate Index (ACI). The ACI provides an aggregate indicator of the frequency of severe weather (such as extreme temperatures, heavy precipitation, drought and high wind) and the extent of sea level rise for the U.S.

What we uncover is intriguing: The economic repercussions of weather shocks aren't etched in stone. Rather, the consequences of a severe weather shock today are markedly more pronounced than they were decades earlier.

The figures below show the impacts of a one-standard-deviation shock to the extreme weather series (the ACI) on several macroeconomic variables. Each figure shows the impact such a shock would have had if it had occurred at the beginning of our data sample period and if it had occurred at the end of the period. The shaded areas represent 68 percent confidence intervals.

While negligible at the beginning of the sample, the impacts of the severe weather shock become significant at the end, where an increase in the severe weather index reduces the aggregate industrial production growth rate (Figure 1a) and raises both the aggregate unemployment rate (Figure 1b) and the inflation rate (Figure 1c). And these effects aren't fleeting, as they persist for nearly 20 months. Generally, the estimated effects are moderate but non-negligible: Our estimates at the end of the sample imply that severe weather shocks attribute about 1 to 2 percent to the fluctuations of macroeconomic variables.¹

Macroeconomic Implications

The growing intensity of such economic impact points to an unsettling reality: Economic adaptations are seemingly not advancing fast enough to counteract negative weather shocks. These findings echo other studies that found mixed evidence of climate adaptation in the U.S., such as the 2021 book Adapting to Climate Change: Markets and the Management of an Uncertain Future.

These findings are also salient to an ongoing discussion among policymakers in advanced countries on the impact of climate-related shocks on price stability.² Our research brings a critical piece of information to this discourse. We confirm that severe weather does indeed influence inflation persistently, with fluctuations in food and energy prices playing significant roles. This knowledge could be helpful to central banks as they navigate the tricky waters of inflation management in a time where food and energy inflation have been important.

Beyond inflation, the persistent negative effects of severe weather shocks on economic growth underscore the potential importance of integrating resilience into our economic strategies. The sustained decline in industrial output and increase in unemployment rates highlight the susceptibility of key economic sectors to weather shocks. As a result, investment in weather-resilient infrastructure, alternative production technologies and workforce upskilling becomes crucial to bolster economic resilience.

Our research adds to the rapidly expanding body of literature that's focused on assessing the economic impacts of weather shocks. While most of these studies concentrate on sectors directly exposed to outdoor weather conditions, our work broadens the view. We demonstrate that weather shocks can cause significant disruptions to the broader U.S. economy.

Conclusion

There is a popular notion that the effects of severe weather shocks such as natural disasters are short lived and can even spur local economic growth because of rebuilding efforts.³ However, new findings from our ongoing research presents a contrasting scenario at a national level. Through the lens of a highly flexible model, we find that severe weather shocks inflict long-lasting damages on industrial growth. This divergence could be explained by federal disaster aid to affected localities, which accelerates the local rebuilding process but results in (among other things) a fiscal cost at the national level, though we do not evaluate these additional costs directly. Our analysis considers these national costs, thus providing a more comprehensive view of the impacts of severe weather shocks.

In conclusion, our findings bring into focus what appears to be a growing influence of weather shocks on economic activity and its stability. They emphasize the pressing need for not only acknowledging severe weather-related shocks as a critical player in our economic narrative but also understanding the evolving nature of this relationship.

Toan Phan is a senior economist in the Research Department at the Federal Reserve Bank of Richmond.

To cite this Economic Brief, please use the following format: Phan, Toan. (August 2023) "A New Look at the Effects of Weather Shocks Over Time." Federal Reserve Bank of Richmond Economic Brief, No. 23-25.

This article may be photocopied or reprinted in its entirety. Please credit the authors, source, and the Federal Reserve Bank of Richmond and include the italicized statement below.

Views expressed in this article are those of the authors and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.