Climate Change and Economic Conditions of Fifty (50) US States: The “Effect Modifier” of Interest Rate in a Semi-Parametric Smooth Varying-Coefficient

We utilize monthly state-level data from 50 U.S. states to provide the first evidence regarding the role of interest rates as effect modifiers in the commonly held assumption that climate change adversely affects economic conditions. Employing a semi-parametric smooth varying coefficient model (SVCM), we analyze the economic impact of climate change while allowing the coefficient related to economic conditions to vary smoothly with the interest rate (the effect modifier) from April 1987 to December 2022. Our findings indicate that the widely accepted belief in a negative impact from climate change is particularly evident in the coldest states in the U.S. Additionally, we observe that this negative effect manifests as a slower rate of improvement in economic conditions in some of the ten hottest states. We confirm that the effect modifier plays a significant role in about 80% of the states studied. While most states experienced a negative effect of climate change prior to the Global Financial Crisis (GFC), the results largely reverse in its aftermath. From a policy perspective, our validation of heterogeneity in the relationship between climate change and state-level economic conditions suggests that for a geographically diverse economy like the U.S., targeted initiatives tailored to mitigate the economic effects of climate change in specific states are the most effective approach.