Macroeconomic Consequences of Natural Disasters : A Modeling Proposal and Application to Floodsand Earthquakes in Turkey

Turkey is vulnerable to natural disasters that can generate substantial damages to publicand private sector infrastructure capital. Earthquakes and floods are the most frequent hazards today, and flood risksare expected to increase with climate change. To ensure stability and growth and minimize the welfare impact ofthese disasters, these shocks need to be managed and accounted for in macro-fiscal and monetary policy. Tosupport this process, the World Bank Macrostructural Model is adapted to assess the macroeconomic effects of natural(geophysical or climate-related) disasters. The macroeconomic model is extended on several fronts: (1) adistinction is made between infrastructure and non-infrastructure capital, with complementary orsubstitutability between the two categories; (2) the production function is adjusted to account for short-termcomplementarity across capital assets; (3) the reconstruction process is modeled in a way that accounts forpost-disaster constraints, with distinct processes for the reconstruction of public and private assets. The resultsshow that destroyed infrastructure capital makes the remaining non-infrastructure capital less productive, whichmeans that disasters reduce the total stock of capital, but also its productivity. The welfare impact of adisaster—proxied by the discounted consumption loss—is found to increase non-linearly with direct asset losses.Macroeconomic responses reduce the welfare impact of minor disasters but magnify it when direct asset losses exceed theeconomy’s absorption capacity. The welfare impact also depends on the pre-existing economic situation, the abilityof the economy to reallocate resources toward reconstruction, and the response of the monetary policy.Appropriate macro-fiscal and monetary policies offer cost-effective opportunities to mitigate the welfare impactof major disasters.