The impact of Climate on Economic and Financial Cycles: A Markov-switching Panel Approach

TL;DR

This study investigates how climate shocks influence economic and financial cycles in European countries using a Bayesian Panel Markov-switching model, revealing asymmetric impacts across phases and countries, mainly through manufacturing output channels.

Contribution

It introduces a novel Bayesian Panel Markov-switching framework to analyze the joint effects of climate shocks on business and financial cycles across multiple countries.

Findings

Extreme weather events affect economies asymmetrically across phases.

Climate shocks impact EU economies heterogeneously.

Manufacturing output is the primary channel for climate impact.

Abstract

This paper examines the impact of climate shocks on 13 European economies analysing jointly business and financial cycles, in different phases and disentangling the effects for different sector channels. A Bayesian Panel Markov-switching framework is proposed to jointly estimate the impact of extreme weather events on the economies as well as the interaction between business and financial cycles. Results from the empirical analysis suggest that extreme weather events impact asymmetrically across the different phases of the economy and heterogeneously across the EU countries. Moreover, we highlight how the manufacturing output, a component of the industrial production index, constitutes the main channel through which climate shocks impact the EU economies.