Researchers link climate events to regional economic output

Extreme heat waves and droughts are increasingly threatening economic growth across the European Union, with the agricultural sector in regions such as Cyprus facing substantial risks from compounding climate shocks, a new study published by the European Central Bank (ECB) has revealed.

The research, which analysed 1,117 regions between 2002 and 2022, developed new climate-augmented models to predict how extreme weather events influence the gross value added per capita across different economic sectors.

Coinciding heat waves and droughts were found to be most frequent in Mediterranean countries, specifically Italy, Spain, Cyprus and Malta, alongside parts of central and eastern Europe, with the frequency of these compounding events rising notably in recent years.

The authors of the study, Sarah Spiteri, Léonore Lebouteiller, Nicole Vorderobermeier, Mar Delgado-Téllez and Andrej Ceglar, found that machine learning methods substantially improved the accuracy of economic predictions by capturing complex climate-economic interactions that traditional linear models often miss.

The most pronounced negative impacts were identified in the agricultural sector, where simulations of extreme climate scenarios suggest that annual growth could fall by between 1.9 and 7.6 percentage points in most regions.

The industrial sector is less affected by these climate extremes, while manufacturing remains broadly stable, a resilience that likely stems from the buffering role of indoor production environments against heat and drought, the researchers noted.

The findings highlight the importance of integrating climate information into short-term economic monitoring tools, according to the paper.

“Climate-augmented predictions using machine learning methods can support the identification of sectors and regions most exposed to compounding climate extremes, to support policymaking and guide the design of targeted and effective adaptation strategies,” the authors stated.

The study indicates that while linear models struggle to represent the economic effects of climate extremes, nonlinear channels play a critical role in how these shocks propagate through the economy.

Droughts and heat waves have increasingly interacted and cascaded across sectors, amplifying socio-economic impacts across the continent, the report explained.

Beyond agriculture, drought-driven disruptions to river transport, electricity generation, water-dependent manufacturing and tourism further propagate through production networks and supply chains, increasing costs and constraining output.

More than 40 per cent of bank lending in the euro area is concentrated in firms highly exposed to drought and strongly dependent on surface water provision, with exposures especially pronounced in southern and western Europe, the study cautioned.

“These dynamics can also affect financial institutions through higher credit risk, reduced collateral values, operational disruptions and market volatility,” the researchers concluded.