The economic impact of floods

Prepared by Guzmán González-Torres Fernández and Miles Parker

Published as part of the ECB Economic Bulletin, Issue 1/2025.

Extreme weather events like the devastating flash floods that hit Spain last October have substantial human, social and economic impacts. Climate change is making these types of event more commonplace and the trend is predicted to go on rising. Moreover, it is not only increasing frequency that is of concern but also greater potency, as evidenced in south-eastern Spain, which until now has not seen as frequent flooding as other regions in Europe (Figure A). In October 2024, some weather stations near Valencia recorded a year’s worth of rain in just eight hours.^[1] By one early estimate, the event was made twice as likely, and 12% more powerful, than it would have been in the absence of human-made climate change.^[2]

Figure A

Distribution of floods across European regions (1995-2022)

(absolute number)

On top of the devastating effects for society and the sudden disruption of economic activity, the full impact of extreme weather events over the medium and long run can be significant, particularly in the context of a changing climate. First, while the short-run costs are generally confined to the immediate damage and disruption caused by the events themselves, changes to investment, labour supply and productivity could potentially prolong the economic effects. Second, extreme weather events are often relatively local, prompting migration dynamics that can slow down a possible economic recovery. And third, the effects of extreme weather events depend on initial climate conditions. As climate change alters baseline temperatures and precipitation patterns, the economic consequences of such events over the business cycle may worsen in the future.

Floods can affect both supply and demand in the economy, making the overall impact on inflation uncertain.^[3] Disruptions to supply and infrastructure can increase costs for firms and encourage them to raise their prices. At the same time, job losses and lower household incomes, coupled with greater uncertainty, can depress demand. There are few studies of the impact of floods on inflation, but what is available points to an immediate, but short-lived increase in food prices and a more prolonged decrease in core inflation, as short-term supply disruptions give way to weaker demand.^[4] The overall impact on prices likely depends on how quickly and fully supply and infrastructure are rebuilt.

Turning to the effects on real economic activity in more detail, the impact of floods can vary greatly across sectors and regions.^[5] Whereas flooding is typically followed by an extended yet temporary period of booming construction in high-income regions, we observe no such surge in construction in middle-income regions (Chart A).^[6] At the same time, we find evidence of a permanent negative shift in the level of industrial gross value added in middle-income regions and a positive shift in high-income regions. In terms of sectors other than construction, some studies find that moderate flooding can boost agricultural production in the year following a flood, perhaps as a result of greater rainfall boosting agricultural productivity in future harvests.^[7] But this effect seems to dissipate with severe flooding, possibly due to soil erosion offsetting the beneficial impact of rain.

Chart A

Medium-run effects of floods on sectoral gross value added by initial income level

(percentage change)

These sectoral trends hint at the importance of promptly addressing infrastructure damage to avoid permanent output losses (Chart B). In high-income regions, the event is followed by more investment and higher GDP, consistent with the reconstruction boom implied by the sectoral developments. There is evidence of higher total factor productivity in these regions too, showing that it may be possible to “build back better”. However, this higher investment does not occur in middle-income regions.

Chart B

Medium-run effects of floods on regional output by initial income level

(percentage change)

Insurance coverage and economic development are key for local and regional European economies to take advantage of risk-sharing mechanisms which can help alleviate local economic damage. Economic and institutional characteristics that strongly correlate with income, such as financial constraints, quality of governance and public infrastructure, may affect long-run economic outcomes.^[8],[9] Higher rates of insurance coverage can hasten reconstruction and reduce the long-run impact of flooding. That said, only a quarter of climate-related damages are currently covered by insurance in Europe, with the share of coverage below 5% in some economies.^[10] The ECB, together with the European Insurance and Occupational Pension Authority (EIOPA), has recently outlined a potential EU-level solution to bolster catastrophe insurance provision, building on existing national and EU structures.^[11]

The economic impact of flooding also spreads beyond the immediately affected areas through supply-chain linkages. A study of the 2021 floods in Belgium highlights significant disruption to those firms directly affected by the event.^[12] These companies saw their sales fall by an average of 15%, and there was an increased likelihood of failure. At the same time, firms in unaffected regions also suffered reduced sales when their suppliers were affected. These supply-chain-induced disruptions lasted for a year following the floods, as firms found it difficult to quickly reorient supply chains away from long-run suppliers.

While it is essential to eliminate carbon emissions to contain the frequency and potency of floods in the future, it is possible to lower their incidence and likelihood at shorter horizons. Evidence shows that adaptation by increasing the stock of capital devoted to flood defences significantly reduces the incidence of flooding two to four years later.^[13] It is, however, less certain that these defences reduce damage once a severe flood occurs. Reiterating the above results, institutional and economic differences across regions are likely to play a crucial role in determining adaptation. Investment in flood defence capital is more likely to be carried out in high-income regions with high-quality institutions. Improvements in legal frameworks and financial innovation are thus needed at both national and European levels to alleviate the current substantial adaptation financing gap.^[14]