The effects of temperature and rainfall anomalies on Mexican inflation

Technical Deep Dive: The effects of temperature and rainfall anomalies on Mexican inflation

Overview

This study examines the impacts of temperature and precipitation anomalies on macroeconomic outcomes in Mexico, specifically real GDP per capita and headline inflation. It uses a regional panel dataset covering seven geographic regions within Mexico from 2004-2024. The analysis employs two econometric approaches: local projections to assess inflation effects and an autoregressive distributed lag (ARDL) model to evaluate GDP per capita impacts.

Problem & Context

Mexico is a highly biodiverse country with a large population, and its economy is significantly dependent on natural resource exploitation. Previous studies have found that climate change and associated extreme weather events could have substantial effects on Mexico's agricultural sector and overall economic growth. However, the existing literature has focused primarily on sectoral or regional impacts, with limited analysis of the macroeconomic implications of temperature and precipitation fluctuations.

This study aims to fill this gap by providing a comprehensive assessment of how climate anomalies, measured as deviations from historical norms, affect both real GDP per capita and headline inflation in Mexico. Understanding these relationships is crucial given the potential for climate change to undermine central banks' ability to maintain price stability and meet inflation targets.

Data & Experimental Setup

The authors constructed a quarterly regional panel dataset covering seven geographic regions in Mexico from 2004-2024. The key variables include:

• Macroeconomic outcomes:
  • Real GDP per capita
  • Headline inflation
  • Inflation sub-components (food, non-food goods, services, agriculture, energy)
  • Sectoral GDP per capita (primary, secondary, tertiary)
• Climate variables:
  • Population-weighted temperature anomalies
  • Population-weighted precipitation anomalies

Climate anomalies were calculated as deviations from 30-year historical norms, following the approach of Kahn et al. (2021). This helps address potential biases introduced by trends in temperature and precipitation.

Methodology

The study employs two complementary econometric approaches:

1. Local Projections (for inflation): This method, developed by Jordà (2005), estimates the dynamic effects of temperature and precipitation anomalies on inflation and its components using a sequence of regressions.
2. Autoregressive Distributed Lag (ARDL) Model (for GDP per capita): This approach, as used by Kahn et al. (2021), models the long-run relationship between climate anomalies and real GDP per capita, accounting for the dynamic adjustments.

Both methods leverage the regional variation in the panel dataset to identify the effects of climate anomalies on the macroeconomic outcomes of interest.

Results

The key findings of the analysis are:

• Neither temperature nor precipitation anomalies have a statistically significant effect on real GDP per capita, headline inflation, or their components.
• These results are consistent with existing evidence that finds no effect or a negligible impact of climate-related events on Mexico's GDP and inflation.
• For example, under the Representative Concentration Pathways (RCP) 2.6 and 8.5 scenarios, Kahn et al. (2021) estimate that the projected GDP per capita impact for Mexico by 2030, 2050, and 2100 ranges from a 0.10-0.23% increase to a 0.64-5.54% loss.

Interpretation

The lack of statistically significant effects on both GDP per capita and inflation suggests that Mexico's economy may be relatively resilient to the short-term impacts of temperature and precipitation fluctuations, at least within the historical range observed in the sample period.

This could be due to several factors:

• Mexico's economy may have adapted to cope with climate variability, minimizing the macroeconomic consequences.
• The primary sector, which is most vulnerable to weather shocks, may have a small enough share of GDP that its impacts are not strongly reflected in aggregate measures.
• Offsetting effects, such as reconstruction-related investment following extreme events, may be balancing out initial disruptions.

However, the analysis does not rule out the possibility of more severe long-term impacts of sustained climate change, as suggested by the GDP per capita projections under the RCP scenarios.

Limitations & Uncertainties

• The analysis is limited to the historical period from 2004-2024 and may not capture the effects of more extreme climate scenarios projected for the future.
• The use of regional aggregates could mask heterogeneous impacts at the state or local level, which may be important for understanding vulnerability and designing targeted policies.
• The study does not explore potential nonlinear or asymmetric effects of temperature and precipitation anomalies, which have been documented in some previous research.
• The analysis focuses on Mexico specifically and may not generalize to other countries with different economic structures and climate vulnerabilities.

What Comes Next

To build on this work, future research could:

• Extend the analysis to explore potential nonlinear or asymmetric effects of climate anomalies on macroeconomic outcomes.
• Disaggregate the analysis to the state or local level to identify regional heterogeneity in climate sensitivities.
• Investigate the sectoral transmission channels and distributional impacts of climate shocks within Mexico.
• Compare the findings for Mexico with other countries to better understand the role of economic structure and adaptive capacity in mediating climate-economy linkages.
• Incorporate climate change projections and scenarios to assess the potential long-term macroeconomic risks posed by sustained global warming.