Climate Change: Macroeconomic Impact and Implications for Monetary Policy

Climate change and policies to mitigate it could affect a central bank’s ability to meet its monetary stability objective. Climate change can affect the macroeconomy both through gradual warming and the associated climate changes (e.g. total seasonal rainfall and sea level increases) and through increased frequency, severity and correlation of extreme weather events (physical risks). Inflationary pressures might arise from a decline in the national and international supply of commodities or from productivity shocks caused by weather-related events such as droughts, floods, storms and sea level rises. These events can potentially result in large financial losses, lower wealth and lower GDP. An abrupt tightening of carbon emission policies could also lead to a negative macroeconomic supply shock (transition risks). This chapter reviews the channels through which climate risks can affect central banks’ monetary policy objectives, and possible policy responses. Approaches to incorporate climate change in central bank modelling are also discussed.