Abstract
We assess the individual and compounding impacts of COVID-19 and climate physical risks in the economy and finance, using the EIRIN Stock-Flow Consistent model. We study the interplay between banks’ lending decisions and government’s policy effectiveness in the economic recovery process. We calibrate EIRIN on Mexico, being a country highly exposed to COVID-19 and hurricanes risks. By embedding financial actors and the credit market, and by endogenising investors’ expectations, EIRIN analyses the finance-economy feedbacks, providing an accurate assessment of risks and policy co-benefits. We quantify the impacts of compounding COVID-19 and hurricanes on GDP through time using a compound risk indicator. We find that procyclical lending and credit market constraints amplify the initial shocks by limiting firms’ recovery investments, thus mining the effectiveness of higher government spending. When COVID-19 and hurricanes compound, non-linear dynamics that amplify losses emerge, negatively affecting the economic recovery, banks’ financial stability and public debt sustainability.
Highlights
The COVID-19 pandemic has generated a systemic economic shock that is unprecedented in scale
We further develop the EIRIN macrofinancial model (Monasterolo and Raberto, 2018; 2019) to quantitatively assess the impacts of COVID-19, either occurring as an individual shock or compounding with climate physical risks, in the real economy and credit market, considering the role of fiscal and monetary policies introduced during the pandemic crisis
Our study provides a methodological advancement for macrofinancial risk assessment of compound risks, offering insights on weak-spots that are relevant for increasing resilience to compound COVID-19, physical and financial risks at the country level
Summary
The COVID-19 pandemic has generated a systemic economic shock that is unprecedented in scale. It affected several markets simultaneously and fast spread to public and private finance. According to the International Monetary Fund (IMF)’s World Economic Outlook (IMF, 2021), the COVID-19 recession is the deepest since the end of World War II, with 7% output loss relative to the IMF’s 3.4% growth forecast of October 2019, and its consequences will likely be long-lasting. Governments and central banks have reacted in an unprecedented manner to mitigate the socio-economic im-. Pacts of COVID-19, including in low-income countries (The World Bank, 2020a).
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