This changes everything: how compounding COVID-19 and climate risks amplify financial shocks
The COVID-19 pandemic quickly developed from Wuhan (China) into a source of global and material risk, along with climatic events and financial crises. However, approaches to manage the COVID-19 crisis have had a too narrow focus on public health, and on the short-term economic and financial implications that prevent investigating how pandemic risk interplays with the sustainable and inclusive development goals in the next decade (Monasterolo et al. 2020). Neglecting compound risk can lead to underestimate losses, which can be amplified by financial complexity (ibid). Thus, the socio-economic and financial risk implications of compound risk should be analysed to inform policies for building resilience to future pandemics, while avoiding policies that impose unnecessary trade-offs among the economic recovery, health and climate objectives.
To fill this gap, an international team of researchers coordinated by Prof. Billio (Ca' Foscari University of Venice) and Dr. Monasterolo (Wirtschaftsuniversität Wien), in collaboration with the World Bank (WB) Disaster Risk Financing and Insurance (DRFI) Program, is quantitatively assessing compounding COVID-19 pandemic and climatic disasters in developing countries. The analysis combines for the first-time probabilistic disaster risk assessment with macroeconomic dynamic modelling (i.e. the EIRIN Stock-Flow Consistent Agent Based model, Monasterolo and Raberto 2018) to study the economic, financial and distributive effects of compounding COVID-19, climate and financial risk. The analysis focuses on countries characterized by large role of tourism, export of intermediate goods, agricultural commodities, and remittances on GDP, with an initial focus on developing countries.
The research identified the risk transmission channels from combinations of compounding epidemic and climate risks to agents and sectors of the economy and finance, and the drivers of feedback loops that amplify losses. Results obtained so far show that when climatic hazards, such as hurricanes and floods, occur in a country during the COVID-19 pandemic, they can magnify the shock induced by lock-down measures in the economy by increasing firms and workers’ vulnerability. For instance, in the Philippines, climate change affecting the typhons seasons amplifies the economic shock induced by COVID-19 by destroying infrastructures and productive capital in the country, and by decreasing tourism and remittances inflows. This, in turn, generates self-reinforcing supply-demand dynamics that contribute to reverberate the shock in the economy, affecting firms and banks’ investment decisions, employment, households’ consumption, GDP, the balance of payment and debt to GDP ratio. Overall, compound risk can determine long lasting negative effects on the economy, on the stability of the banking sector and on public debt sustainability.
The results are going to support the WB’s DRFI analysis of compound shocks in the economy and the implications for policy response in developing countries.
Monasterolo, I., Billio, M., and Battiston, S. (2020). The importance of compound risk in the nexus of COVID-19, climate change and finance. Available at SSRN: https://ssrn.com/abstract=3622487
Monasterolo, I., Raberto, M (2018). The EIRIN flow-of-funds behavioural model of green fiscal policies and green sovereign bonds. Ecological Economics, 144, 228-243