Transmission of Flood Damage to the Real Economy and Financial Intermediation: Simulation Analysis using a DSGE Model

By Ryuichiro Hashimoto and Nao Sudo

This paper quantitatively assesses the indirect effect of floods on the real economy and financial intermediation in Japan by estimating a dynamic stochastic general equilibrium (DSGE) model that incorporates a mechanism through which floods cause the capital stock and the public infrastructure to depreciate exogenously, using the data on flood damage recorded in the Flood Statistics released by the Japanese government. The result of the analysis is twofold. First, flood shocks dampen GDP from the supply side by reducing the capital stock inputs. The decline in GDP then impairs the balance sheets of firms and financial intermediaries, resulting in disruptions to financial intermediation and thus dampening GDP further from the demand side. Even when the direct damage due to floods is fully covered by insurance, the downward pressure on GDP endogenously deteriorates the balance sheets of these sectors, causing the same mechanism to operate. Second, the quantitative impacts of flood shocks on GDP up to now have been minor compared to the standard structural shocks that are considered important in existing macroeconomic studies, including shocks to total factor productivity (TFP) and the subjective discount factor. According to the estimates that use the relationship between the key variables in our model together with climate change scenarios published by an external organization, the impacts of these shocks could become somewhat larger in the future.

Given that we are recovering from flooding in St. Louis, this hit a nerve. Of course, if you destroy some capital, the economy suffers. But there is this persistent myth that a natural disaster is good because it provides jobs for the recovery. I wonder whether this class of models could say something in this regard when there is under-employment or when a geographically limited area is hit (leading to reallocations).

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: