Seawalls and Stilts: A Quantitative Macro Study of Climate Adaptation

Abstract

We develop a structural macroeconomic model of adaptation investment to reduce the damage from extreme weather. The framework modies the Aiyagari-style model to apply in a new setting in which a continuum of heterogeneous localities experience idiosyncratic extreme weather shocks. Localities can invest in adaptation capital to reduce the damage from extreme weather and they can purchase insurance to smooth consumption. A federal government taxes localities and provides partial disaster relief. We calibrate the model to match variation in FEMA aid per event across US counties with dierent risks of extreme weather. We use the calibrated model to quantify the amount and eectiveness of adaptation capital, the moral hazard consequences of FEMA policy, and the role of adaptation in response to climate change. We nd that storm-related adaptation capital is 0.7 percent of the US capital stock and reduces the damage from extreme weather by one third. Additionally, the moral hazard eects of FEMA policy on adaptation and the associated extreme weather damage are substantial. We introduce climate change into the model as a permanent, increase in the severity of extreme weather. We nd that adaptation reduces the welfare cost of this climate change by 25 percent.