shocks, this paper isolates the main transmission channels of droughts and floods on aggregate macroeconomic outcomes. This allows us to quantify the second-round effects of climate shocks and the induced adjustment dynamics of the main macro variables. In addition, we simulate climate shocks jointly with standard macroeconomic shocks to address their compound effects. To do so, the study exploits the stochastic characteristics of climate shocks, as well as the joint distribution of standard macroeconomic shocks. This paper benefits from relevant background data and analytical studies related to climate shocks and their impacts available for Uruguay, which provide historical estimates of direct losses and stochastic projections of climate shocks under different climate scenarios.

**The contribution of this study is threefold** . First, and more specific to Uruguay, a comprehensive macroeconomic assessment of climate shocks was missing, despite the rich background data and analytics about the historical and expected direct effects of climate shocks in the country. Second, we develop an innovative and detailed approximation to the modeling of droughts, whose transmission mechanisms to aggregate outcomes are often oversimplified. This is particularly important for Uruguay, given its economic structure, but also has potential implications for other countries in Latin America that share its dependence on L&A. Third, of a more general nature, macroeconomic analyses that incorporate the effects of climate shocks do not usually address how they interact with more standard macroeconomic shocks, and thus understate their implied downside risks. Our approach allows for the simultaneous simulation of standard macro shocks (interest rates, external demand, etc.) and climate shocks, hence providing insight into how they jointly affect macroeconomic volatility.

**We find that climate shocks have relevant and persistent effects on aggregate variables** . Droughts in particular represent large and persistent shocks to economic activity and fiscal balances. However, this effect is dynamically complex. Incorporating the temporal pattern of production losses in historical droughts in Uruguay, and linkages between the L&A sector, other productive sectors, and the demand side of the economy, our modeled results imply that indirect effects magnify the direct impact of a drought on economic activity by around 50 percent in the year of occurrence. For the 2022/23 drought, this translates into a 2.8 percent fall in GDP accounting for direct and indirect effects. Given the persistent effect of climate shocks on economic activity, particularly on livestock, GDP, fiscal outcomes, and exports are still lower than in the baseline scenario of no climate shocks the year after the drought. We find small but persistent distributional effects in the short term, with a 0.5 percentage point increase in poverty levels on impact.

**The volatility of a simulated Uruguayan economy only subject to climate shocks reaches 22 percent of historical GDP volatility** . Average real GDP is estimated to fall by up to 0.4 percent because of continued historical climate shocks, and by up to 2.3 percent as a result of one-in-40 years climate shocks. Exports are affected disproportionately, as climate shocks affect activities overrepresented in the export basket. The impact of climate shocks on fiscal accounts is also relevant, reducing the fiscal balance (as a percentage of GDP) by up to 0.5 percentage points for climate shocks that historically occurred once every 40 years. Our results suggest that future changes in the Uruguayan climate associated with higher emissions concentration pathways would tend to worsen the magnitude of the downside risks from droughts by between 18 and 30 percent, and from floods by between 57 and 212 percent. Climate change estimates are subject to large uncertainty given the dispersion of the model’s projected precipitation patterns for Uruguay.

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