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

June 3, 2022
Ryuichiro Hashimoto*1
Nao Sudo*2

Abstract

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.

JEL classification
E32, E37, E44, Q54

Keywords
Climate change, Natural disaster, Physical risk, Financial system, DSGE model

The authors would like to thank the Ministry of Land, Infrastructure, Transport and Tourism, the Japan Meteorological Agency, S. Muto, Y. Sawada, C. Shimizu, J. Yoshida, and the staff of the Bank of Japan, including K. Nakamura, K. Nishizaki, I. Muto, and K. Suzuki, for their valuable comments. The views expressed in this paper are those of the authors and do not necessarily reflect the official view of the Bank of Japan or of the Financial System and Bank Examination Department.

  1. *1Financial System and Bank Examination Department, Bank of Japan
    E-mail : ryuuichirou.hashimoto@boj.or.jp
  2. *2Financial System and Bank Examination Department, Bank of Japan
    E-mail : nao.sudou@boj.or.jp

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