Why climate change is a threat to central bank stability

Mark Carney, former governor of Bank of England, announced the formation of a group of financial companies that will strive to reach net zero by 2050 ahead of a day of discussions on climate finance at the COP26 Climate Change Summit in Glasgow. The Glasgow Financial Alliance for Net ZeroIt includes more than 450 banks and asset managers as well as insurers, and is estimated to have assets of up to $150 trillion.

It is noteworthy that Carney, a former senior banker, is the leader of this coalition of private sector companies. In recent years, activists, researchers and others have noticed this. called for central banks to do moreClimate change. Although central bankers have been discussing the issue extensively, they have mostly focused on its implications for financial security. Carney has warned that this is what Carney meant. climate change could damage the financial systemAs assets are damaged by extreme weather, or become unviable (and therefore uninsurable), and as temperatures rise and climate action becomes normalised, this can result in losses.

Although stability in the financial system is important it is not the main objective of most central banks. Their primary goal is to maintain stable price levels. achieve low inflation. But could climate change affect their ability to achieve this primary goal?

How climate change impacts monetary policy

This issue has been largely ignored by central banks, who have generally shied away from it as if they think they are immune to the impacts of climate change. My co-author Koyesha Mukherjee, and I published a paper recently. researchWe demonstrated that climate change poses a threat to not just financial stability but also prices and inflation.

We identified several ways that climate change could affect price stability. A fall in agricultural production could result in food shortages due to hotter temperatures. This would lead to higher prices as there would be more demand than supply.

Climate-related extreme weather also means more demand for energy (for cooling or heating) but also a fall in supply – thereby driving prices up. Extreme weather also affects countries’ ability to produce exported goods. Exposed to extreme heat, for example, can cause severe heatstroke. less effective at producing goodsAll goods, even those destined for export. This would cause a shortage in goods and impact global market price.

This was proven when we analysed temperature changes and inflation for 107 countries (including 77 developed and 80 developing countries). First, we collected daily average temperatures for each country. This was then converted into an anual figure. We were able to calculate a simplified measure for temperature change from this annual figure. This was then compared with inflation in the country that year.

After excluding countries that experienced hyperinflation or two periods of global inflationary shocks we found that rising temperatures were strongly linked to an increase inflation.

This finding was also confirmed by separate investigations in developing and developed nations. Inflation increases in developed countries are caused by temperature increases. This effect lasts for about a year. This effect was more severe in developing countries, where it lasted for at least six decades after the process began.

What does this mean for central banks?

They will have to adjust their interest rates to adapt to climate change. The effects of climate change will make it more difficult for central banks to accurately forecast economic variables. This could have devastating consequences for the wider economy, making financial crises and recessions more likely. Final, central banks must decide how to best respond to climate-driven fluctuations in inflation and output.

It is vital for central banks that they understand that climate change has a far greater impact than financial stability. In fact, it poses a threat their first primary goal of keeping inflation low and prices stable. They should therefore consider climate change in their decision-making.

In order to respond to inflation correctly, central banks need to be able to identify the source. Green monetary policy, green finance, and even green terrorism are all possible options to slow down the pace of climate change. green quantitative easingCentral banks only purchase assets if there is evidence that the money will be used for green purposes.

This story is part of The Conversation’s coverage on COP26, the Glasgow climate conference, by experts from around the world.

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