Weather Shocks and the Optimal Policy Mix in a Climate-Vulnerable Economy

Using data from a selection of Latin American countries affected by El Niño-Southern Oscillation climate phenomena, we observe that extreme weather events can be highly disruptive for an economy, particularly in the agricultural sector, while also giving rise to inflationary pressures. Motivated by these findings, this paper examines the optimal stabilization policies for a climate-vulnerable economy with two segmented sectors: agriculture (producing food) and manufacturing. In response to climate disasters affecting agriculture, it is found to be optimal to increase fiscal transfers to farmers while maintaining core inflation at its target level. Deviating from the optimal policy mix results in smaller welfare losses as long as core inflation remains stabilized.