Severe weather and financial (in)stability

We quantify the effect of severe weather shocks on the US economy in an environment in which the economy can switch between periods of financial stability and financial instability, like the Great Recession. We estimate a New Keynesian dynamic stochastic general equilibrium model with banks and severe weather events. We show that severe weather shocks: (1) have a negative impact on real and financial US variables, sizeable only in periods of financial instability, but muted effects on nominal variables; (2) are never a relevant source of business cycle fluctuations; (3) transmit mainly via a deterioration in the quality of capital.