Weather Fluctuations, Expectation Formation, and Short-Run Behavioral Responses to Climate Change

Abstract

One premise adopted in most previous studies is that weather fluctuations affect economic outcomes contemporaneously. Yet under certain circumstances, the impact of weather fluctuations in the current year can be carried over into the future. Using agricultural production as an example, we empirically investigate how past weather fluctuations affect economic decision-making by shifting agents’ subjective expectations over future climate. We find that agricultural producers do not form expectations on future climate using only long-run normals, and instead engage in a combination of heuristics, including the availability heuristic and the reinforcement strategy. Adopting these learning mechanisms causes farmers to significantly over-react to more recent fluctuations in weather and water availability when making ex ante acreage and crop allocation decisions.