Abstract
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.
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Notes
- 1.
The NGFS’s first comprehensive report was published in April 2019 (NGFS 2019).
- 2.
A survey of experimental studies reported by Dell et al. (2014) concluded that there is a productivity loss in various cognitive tasks of about 2% per 1 °C for temperatures over 25 °C.
- 3.
Batten (2018) provides a more detailed discussion of the literature.
- 4.
See the minutes of the Federal Open Market Committee Meeting on 20 September 2005.
- 5.
See the minutes of the BoJ Monetary Policy Meeting on 14 March 2011.
- 6.
See the statement of the G7 Finance Ministers and Central Bank Governors released on 18 March 2011, and Bank of Japan (2011).
- 7.
Growth accounting assumes that the output elasticity of energy equals the cost share of energy in production in a competitive economy.
- 8.
The share of bioenergy is assumed to increase in the Representative Concentration Pathway (RCP) 2.6 which is likely to keep the warming below 2 °C (van Vuuren et al. 2011). IEA (2013) also projects that in order to achieve a 50% reduction in energy-related CO2emissions by 2050 (from 2005 levels), biofuels would need to provide 27% of the total global transport fuel, up from 3% currently. But there is a question over the sustainability of large-scale bioenergy production, given the competition with other land and biomass needs, such as food security and biodiversity conservation (Fuss et al. 2014).
- 9.
Climate policy can also have a range of benefits in addition to the gains from reducing future climate change damage: these are often referred to as co-benefits. For example, policies that encourage innovation in low-carbon technologies can spill over to other industries and stimulate economic growth. Moreover, climate policy might result in productivity growth if they improve the allocation of resources or increase their degree of utilisation. Mitigation actions targeting clean energy technologies or energy efficiency are found to induce improvements in air quality by reducing local air pollution such as particulate matter, sulphur dioxide and nitrogen oxides, which are damaging for human health. Co-benefits can be expected to cover a significant part of climate change mitigation costs (see e.g. Bollen et al. 2009; Groosman et al. 2011). An attractive feature of co-benefits is that they occur in the medium run, while the direct benefits of GHG mitigation policies in terms of reduction of the impact of climate change are likely to occur only in the longer run.
- 10.
Other types of climate policies, such as incentives to innovation and investment in low-carbon technologies, can instead lead to an increase in potential supply.
- 11.
Another example is OECD (2015).
- 12.
See Turrell (2016) for a further discussion of ABMs application to macroeconomics.
- 13.
See, for example, Bordo et al. (2001).
- 14.
For a similar diagram for extreme weather events, see Figure 10.1 in Batten et al. (2018).
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Batten, S., Sowerbutts, R., Tanaka, M. (2020). Climate Change: Macroeconomic Impact and Implications for Monetary Policy. In: Walker, T., Gramlich, D., Bitar, M., Fardnia, P. (eds) Ecological, Societal, and Technological Risks and the Financial Sector. Palgrave Studies in Sustainable Business In Association with Future Earth. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-38858-4_2
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