Abstract
We produce novel empirical evidence on the relevance of temperature volatility shocks for the dynamics of productivity, macroeconomic aggregates and asset prices. Using two centuries of UK temperature data, we document that the relationship between temperature volatility and the macroeconomy varies over time. First, the sign of the causality from temperature volatility to TFP growth is negative in the post-war period (i.e., 1950–2015) and positive before (i.e., 1800–1950). Second, over the pre-1950 (post-1950) period temperature volatility shocks positively (negatively) affect TFP growth. In the post-1950 period, temperature volatility shocks are also found to undermine equity valuations and other main macroeconomic aggregates. More importantly, temperature volatility shocks are priced in the cross section of returns and command a positive premium. We rationalize these findings within a production economy featuring long-run productivity and temperature volatility risk. In the model temperature volatility shocks generate non-negligible welfare costs. Such costs decrease (increase) when coupled with immediate technology adaptation (capital depreciation).
Highlights
There is near unanimous scientific consensus that climate change affects human health, behavior, and activity (Patz et al 2005; Deschênes and Moretti 2009; Zivin and Neidell 2014; Cattaneo and Peri 2016) and has a negative impact on economic development (Stern 2007; Hsiang and Meng 2015)
To address some of the issues associated with the use of Integrated Assessment Models (IAMs) to examine the economic costs of climate change, more recent analyses have incorporated empirical evidence indicating that rising temperature levels have a negative impact on the real economic activity (Dell et al 2012; Du et al 2017; Colacito et al 2019) into Dynamic Stochastic General Equilibrium (DSGE) models (Bansal et al 2016; Donadelli et al 2017)
We show novel empirical evidence that increasing uncertainty about temperature variations negatively affects aggregate productivity, economic activity, and asset valuations in the UK after 1950
Summary
There is near unanimous scientific consensus that climate change affects human health, behavior, and activity (Patz et al 2005; Deschênes and Moretti 2009; Zivin and Neidell 2014; Cattaneo and Peri 2016) and has a negative impact on economic development (Stern 2007; Hsiang and Meng 2015). To address some of the issues associated with the use of IAMs to examine the economic costs of climate change, more recent analyses have incorporated empirical evidence indicating that rising temperature levels have a negative impact on the real economic activity (Dell et al 2012; Du et al 2017; Colacito et al 2019) into Dynamic Stochastic General Equilibrium (DSGE) models (Bansal et al 2016; Donadelli et al 2017). We examine the effects of volatility in weather conditions on macro-variables and asset prices We investigate both empirically and theoretically whether shifts in the volatility of temperature affect aggregate productivity, economic growth, welfare, and equity prices.
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