Rare Disasters, the Natural Interest Rate and Monetary Policy*

Abstract

Abstract This article evaluates the impact of rare disasters on the natural interest rate and inflation, and their implications for monetary policy, by using data on natural disasters in OECD countries. Ex‐ante , disaster risk behaves as a negative demand shock and permanently lowers the natural rate and inflation. These effects become larger and nonlinear if the frequency of extreme natural disasters increases. Ex‐post , a disaster realization leads to temporarily higher or lower natural rate and inflation depending on whether supply‐ or demand‐side effects prevail. The article hence shows the importance of disentangling disaster strikes from disaster risk in shaping monetary policy.