Time-Varying Effects of Climate Change Shocks on Macroeconomic Fluctuations in Peru

This paper uses the time-varying parameter vector autoregression model with stochastic volatility (TVP-VAR-SV) of Chan and Eisenstat (2018) to quantify the effects of two climate change (CC) shocks on macroeconomic fluctuations in Peru, assess their relative importance, and trace their evolution over time. The two shocks are the El Ni˜no phenomenon (ENP) and deviations of average temperature from its historical mean. Bayesian model selection criteria indicate that the best-fitting models allow only some parameters to vary over time, while the inclusion of the stochastic volatility (SV) component is essential for model performance. The results yield three main findings. First, both CC shocks operate as negative supply shocks: they reduce gross domestic product (GDP), increase inflation, and raise the interest rate. They also explain GDP and inflation dynamics better than interest-rate dynamics. GDP falls by 0.8 (0.05-0.20) pp in response to the ENP (average temperature deviation) shock, while inflation rises by 0.25 pp in response to both shocks. By sector, primary GDP falls by 1.5 pp in response to ENP shock, with a 5.0 (0.8–1.0) pp drop in fishing (agriculture) GDPs. In response to temperature deviations shock, primary GDP falls by 1.2–1.4 pp, fishing (agriculture) GDP by 2.0 (1.2–1.5) pp. Second, the effects of both shocks are time-varying and more damaging for the primary sector. ENP has larger and more significant effects on GDP in 1998Q2 and 2017Q2, and on inflation in 2017Q2. Average temperature deviations have larger and more significant effects on GDP in 1994Q3 and 2005Q1, and on inflation in 1994Q3 and 2019Q1. Third, the ENP shock is more important and statistically significant than the average temperature deviation shock in explaining macroeconomic performance. ENP also helps explain the sharp GDP contractions and inflation increases observed in 1998 and 2017.

JEL Classification: C32, C52, E32, O44, Q54.

Keywords: Climate Change Shocks; El Niño Phenomenon; Temperature Deviations; Macroeconomic Fluctuations; TVP-VAR-SV Models; Peruvian Economy.

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