Modeling the macroeconomic consequences of natural disasters: Capital stock, recovery dynamics, and monetary policy

Abstract

Natural disasters can cause substantial damage to public and private sector infrastructure capital, generating macroeconomic losses through complex channels. These shocks must be managed and accounted for with macrofiscal and monetary policy to minimize their welfare impacts. To support this process, we adapt the World Bank Macrostructural Model to capture key transmission channels of natural (geophysical or climate-related) disasters and their immediate aftermath. The macroeconomic model is extended on several fronts: (1) a distinction is made between infrastructure and noninfrastructure capital; (2) the production function is adjusted to account for short-term complementarity across capital assets; (3) the reconstruction process is modeled to consider postdisaster constraints, with distinct processes for the reconstruction of public and private assets. Destroyed infrastructure capital makes the remaining noninfrastructure capital less productive, which means that disasters reduce the total stock of capital and its marginal productivity. Upon applying the model to Türkiye data, the welfare impact of a disaster — proxied by the discounted consumption loss — is found to increase nonlinearly with direct asset losses. Macroeconomic responses reduce the welfare impact of minor disasters but magnify it when direct asset losses exceed the economy’s absorption capacity. The welfare impact also depends on the preexisting economic situation, the ability of the economy to reallocate resources toward reconstruction, and the response of monetary policy. Appropriate macrofiscal and monetary policies offer cost-effective opportunities to mitigate the welfare impact of major disasters.