Weather, Climate and the Economy: Welfare Implications of Temperature Shocks

This paper examines the effects of weather shocks and climate change in the economy when rising temperatures independently affect household preferences and production technology. Direct temperature damages to the agent's preferences amplify the negative economic and welfare effects of temporary and permanent temperature increases. In our model, households value nature and dislike energy use in production. Temperature anomalies increase the disutility of energy use leading agents to reduce its use more dramatically when temperature increases. The short-run response of welfare to an unanticipated change in temperature is remarkably different when temperature directly affects preferences - welfare rises initially and then decreases as it returns to its steady state along with the temperature anomaly. Results of our analysis suggest that the consumption equivalent welfare for a 2.0C permanent increase in temperature is approximately 3 percent of GDP.