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Climate change

El Nino's Impact on Economies: Insights from Peru's Climate Risks

Strategic Insights

— 2 min read

The Peruvian economy is severely vulnerable to the disruptions caused by El Nino Costero, a local version of the El Nino-Southern Oscillation (ENSO). This climate event triggers natural disasters such as droughts, floods, and heatwaves, which alter business cycles and pose significant challenges for monetary policy. Researchers have estimated the impact of large El Nino events on inflation, aggregate output, and sectoral output using monthly Peruvian data from January 1994 to December 2019.

Key Takeaways:

  • A large El Nino shock is a persistent supply-side shock that induces inflationary pressures while GDP contracts. The effects are long-lasting and differ across different sectors.
  • Primary sectors drive immediate and substantial economic contractions and increases in inflation, but only in the short term.
  • In the medium term, the negative effects on non-primary sectors become more significant and persistent.
  • The semi-structural model, with non-linear transmission channels, allows exploration of the implications of recurrent supply shocks.
  • A hawkish monetary policy stance remains crucial to stabilize inflation dynamics, despite the relevant cost in economic activity resulting from such a policy stance.
  • For more frequent and intense shocks over time, deviations in inflation from its target weaken the credibility of monetary authorities.
  • The Peruvian economy, particularly vulnerable to El Nino Costero, faces significant challenges in monetary policy due to the alterations in business cycles caused by natural disasters.
  • The impact of El Nino on the economy is not limited to primary sectors, but also affects non-primary sectors in the medium term.
  • The semi-structural model used in this study provides valuable insights into the implications of recurrent supply shocks.

Statistics:

  • The study used monthly Peruvian data from January 1994 to December 2019 to estimate the impact of large El Nino events on inflation, aggregate output, and sectoral output.
  • The study found that a large El Nino shock induces inflationary pressures while GDP contracts, with effects that are long-lasting and differ across different sectors.
  • The semi-structural model used in this study was calibrated to replicate the empirical findings, including the five non-linear mechanisms triggered by El Nino Costero.
  • The study found that primary sectors drive immediate and substantial economic contractions and increases in inflation, but only in the short term.
  • The negative effects on non-primary sectors become more significant and persistent in the medium term.

Sources:

  • The paper was produced as part of the BIS Consultative Council for the Americas (CCA) research network and conference on "Macro-financial implications of climate change and environmental degradation", held in Bogota on 2-3 December 2024.
  • The study used monthly Peruvian data from January 1994 to December 2019.

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