The Economic and Policy Consequences of Catastrophes

28 Pages Posted: 18 Sep 2009

See all articles by Robert S. Pindyck

Robert S. Pindyck

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Multiple version iconThere are 2 versions of this paper

Date Written: September 15, 2009

Abstract

What is the likelihood that the U.S. will experience a devastating catastrophic event over the next few decades – something that would substantially reduce the capital stock, GDP and wealth? What does the possibility of such an event imply for the behavior of economic variables such as investment, interest rates, and equity prices? And how much should society be willing to pay to reduce the probability or likely impact of such an event? We address these questions using a general equilibrium model that describes production, capital accumulation, and household preferences, and includes as an integral part the possible arrival of catastrophic shocks. Calibrating the model to average values of economic and financial variables yields estimates of the implied expected mean arrival rate and impact distribution of catastrophic shocks. We also use the model to calculate the tax on consumption society would accept to reduce the probability or impact of a shock.

Keywords: Catastrophes, disasters, rare events, economic uncertainty, consumption tax, national security

JEL Classification: H56, G01, E20

Suggested Citation

Pindyck, Robert S. and Wang, Neng, The Economic and Policy Consequences of Catastrophes (September 15, 2009). MIT Sloan Research Paper No. 4751-09, Available at SSRN: https://ssrn.com/abstract=1474034 or http://dx.doi.org/10.2139/ssrn.1474034

Robert S. Pindyck (Contact Author)

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Neng Wang

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