Extreme weather shocks and state-level inflation of the United States

This study investigates the impact of a metric of extreme weather shocks on 32 state-level inflation rates of the United States (US) over the quarterly period of 1989:01 to 2017:04. In this regard, we first utilize a dynamic factor model with stochastic volatility (DFM-SV) to filter out the national factor from the local components of overall, non-tradable and tradable inflation rates, to ensure that the effect of regional climate risks is not underestimated, given the derived sizeable common component. Second, using impulse responses derived from linear and nonlinear local projections models, we find statistically significant increases in the state (and national) factor of overall inflation rates, with the aggregate effect being driven by the tradable sector relative to the non-tradable one, particularly across the agricultural states in comparison to the non (less)-agricultural ones. Our findings have important policy implications.