the most recent data available for the economic and climate variables and provide country-specific policy recommendations.

We extend this analysis by testing for threshold and cascading risks in MFMod and by highlighting the importance of fiscal policy in mitigating environmental disaster risks. To do so, we simulate the effect of natural disasters of different sizes in the presence of other macroeconomic shocks. In particular, we simulate the effects of capital destruction from natural disasters of the magnitudes of 5 and 10 percent of the economy’s capital stock. We repeat these exercises in the presence of external shocks to test for risk compounding in MFMod. Our model setup follows Hallegatte, Jooste, and McIsaac (2024) who focus on monetary policy. Natural disasters destroy a fraction of the economy’s capital stock which lowers the economy’s productivity. Reconstruction efforts can repair affected capital and help to restore productivity. In the absence of reconstruction, capital depreciates at the regular rate. In the model of Hallegatte, Jooste, and McIsaac (2024), reconstruction occurs via redirection of existing public investment.<sup>5</sup> We keep this form of reconstruction financing as our baseline and extend the analysis to the following public funding sources: debt financing, expenditure cuts, and revenue increases.<sup>6</sup> The latter two are set to offset increases in public investment in a budget-neutral manner. Given our focus on fiscal policy's role in financing reconstruction, we do not consider measures to increase disaster preparedness (for example, investments in adaptation, contingency funds, or private insurance).<sup>7</sup> Figure 3 and tables 2-6 present our simulation results.

A 5 percent of the capital stock destruction without any reconstruction efforts (reported in table 2) induces an immediate drop in GDP of nearly 2 percent relative to the no-disaster baseline, with output loss increasing to nearly 2.5 percent over the next 15 years as the economy shifts to a lower potential output trajectory, and a persistent deviation from baseline for several decades. Table 2 reports key macroeconomic variables over a 30-year period, all relative to the baseline in which the shock does not occur (note that in MFMod potential GDP relies on lagged capital stock; thus, as a result, the shock to capital only impacts the economy in the following year). The bottom two rows illustrate the supply-side implications of the shock with potential GDP and capital stock

> 5 Damages to capital stock are captured by a damage function in destructed capital KD and normal capital K, so that 1 K<sup>D</sup> 1−α effective capital stock is K<sup>eff</sup> = (1 − K ) K. With potential output of standard Cobb-Douglas form, terms can be K<sup>D</sup> rearranged to produce the potential output after damages: Y<sup>pot</sup> = AL<sup>α</sup> (K<sup>eff</sup> )<sup>1−α</sup> = (1 − K ~~)~~ AL<sup>α</sup> K<sup>1−α</sup> .

> 6 The effects of revenue mobilization using tax increases vary across versions of MFMod, as the elasticity of some revenue items can differ.

> 7 We use the off-the-shelf version of MFMod as recently applied to an island economy. MFMod already includes a damage module to simulate the effects of natural disasters. We rely on this module for our simulations and extend it to allow for fiscal funding of reconstruction investments.

12