"The Economic and Policy Consequences of Catastrophes"
Publication type: Working paper
What is the likelihood that the U.S. will experience a devastating catastrophic event over the next few decades that would substantially reduce the capital stock, GDP and wealth? And how much should society be willing to pay to reduce the probability or impact of a catastrophe? We show how answers to these questions can be inferred from economic data. We provide a framework for policy analysis which is based on a general equilibrium model of production, capital accumulation, and household preferences. Calibrating to economic and financial data provides estimates of the annual mean arrival rate of shocks and their size distribution, as well as investment, Tobin's q, and the coefficient of relative risk aversion. We use the model to calculate the tax on consumption society would accept to limit the maximum size of a catastrophic shock, and the cost to insure against its actual impact.
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