How Persistent are Climate-Related Price Shocks? Implications for Monetary Policy
HowPersistentareClimate-RelatedPriceShocks? ImplicationsforMonetaryPolicy AlainKabundi,MontfortMlachila,andJiaxiongYao WP/22/207 IMFWorkingPapersdescriberesearchinprogressbytheauthorsandarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthorsanddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2022 OCT ©2022InternationalMonetaryFundWP/22/207 IMFWorkingPaper AfricanandMonetaryandCapitalMarketsDepartments HowPersistentareClimate-RelatedPriceShocks?ImplicationsforMonetaryPolicyPreparedbyAlainKabundi,MontfortMlachila,andJiaxiongYao* November2022 IMFWorkingPapersdescriberesearchinprogressbytheauthorsandarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthorsanddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Climatechangeislikelytoleadtomorefrequentandmoreseveresupplyanddemandshocksthatwillpresentachallengetomonetarypolicyformulation.Themainobjectiveofthepaperistoinvestigatehowclimateshocksaffectconsumerpricesinabroadrangeofcountriesoveralongperiodusinglocalprojectionmethods.Itfindsthattheimpactofclimateshocksoninflationdependsonthetypeandintensityofshocks,countryincomelevel,andmonetarypolicyregime.Specifically,droughtstendtohavethehighestoverallpositiveimpactoninflation,reflectingrisingfoodprices.Interestingly,floodstendtohaveadampeningimpactoninflation,pointingtothepredominanceofdemandshocksinthiscase.Overthelongrun,thedominantmonetarypolicyparadigmofflexibleinflationtargetingfacedwithsupply-inducedclimateshocksmaybecomeincreasinglyineffective,especiallyinLIDCs.Moreresearchisneededtofindviablealternativemonetarypolicyframeworks. RECOMMENDEDCITATION:Kabundi,Alain,MontfortMlachila,andJiaxiongYao.2022.“HowPersistentareClimate-RelatedPriceShocks?ImplicationsforMonetaryPolicy,”IMFWorkingPaper22/207. JELClassificationNumbers: E31,E50,E52,Q54 Keywords: climatechange,monetarypolicy,monetarypolicymodels Author’sE-MailAddress: akabundi@imf.org;mmlachila@imf.org;jyao@imf.org Wewouldliketothank,withoutimplicationMokhtarBenlamine,GastonGelos,StephaneHallegatte,DenizIgan,LuisBrandaoMarques,MaxwellMkondiwa,SampawendeJ.Tapsoba,andseminarparticipantsattheIMFfortheirvaluablecomments. Contents 1.Introduction3 2.RelatedLiterature5 3.DataandStylizedFacts7 3.1DataSourcesandTransformations7 Disasters7 TemperatureandPrecipitationShocks8 3.2StylizedFacts9 4.EmpiricalStrategy14 4.1Methodology14 4.2ImpactofNaturalDisastersonInflation15 4.3ImpactofClimateShocksonInflation24 Results25 5.Conclusion28 APPENDICES A.NaturalDisastersandFoodInflationattheSubnationalLevel30 B.ResultswithAdditionalControlVariables37 C.TheRoleofFoodInflation39 D.TheImpactofFloodsonFoodProduction40 E.AlternativeMeasureofMonetaryAutonomy41 F.AlternativeMeasureofTemperatureandPrecipitation43 References44 FIGURES 1.FrequencyofNaturalDisastersbyDisasterType11 2.FrequencyofNaturalDisastersbyCountryType11 3.TemperatureandPrecipitationZ-ScoreDistribution14 4.ResponseofInflationtoNaturalDisasterShockbyTypeandIntensity17 5.ResponseofInflationtoDroughts,Floods,andStormsinAEs19 6.ResponseofInflationtoDroughts,Floods,andStormsinEMs20 7.ResponseofInflationtoDroughts,Floods,andStormsinLIDCs21 8.ResponseofInflationinAEstoDroughts,Floods,andStormsbyIT-Regime22 9.ResponseofInflationinEMstoDroughts,Floods,andStormsbyIT-Regime23 10.ResponseofFoodPriceInflationDroughts,Floods,andStorms24 11.ImpactofClimateShocksonInflation26 12.ImpactofPositiveandNegativeClimateShocksonInflation27 13.ImpactofClimateShocksonInflation:RoleofInflationTargeting28 TABLES 1.FrequencyDistributionsofNaturalDisasterbyTypeinPercentageofTotalObservations12 2.SummaryStatisticsofInflation,TemperatureandPrecipitation(1970–2018)13 1.Introduction Climatechangeislikelytoleadtomorefrequentandmoreseveresupplyanddemandshocksthatwillpresentachallengetomonetarypolicyformulation.Onthesupplyside,extremeweatherevents,suchasdroughts,willlikelyincreasefoodpricevolatility.Whileshocksmaybetwo-sided,adversesupplyshocks,inparticular,createdifficulttrade-offsformonetarypolicysincetheymaypushpricesupandoutputdown(Klomp2020).Moreover,frequentsupplyshockswillmakeitmoredifficulttodisentanglepermanentfromtransitoryshocks,complicatingtheanalysisofpriceandoutputdata,andcreatingcommunicationandcredibilitychallenges(NGFS2020). Policyuncertaintyaboutclimate-relatedtransitionpoliciescouldaffectdemand,investment,andinflationexpectations.Morefrequentshocksandhigheruncertaintymayalsocontributetodepressingpotentialoutputandtotheloweringoftheequilibriumrealinterestrate(BylundandJonsson2020),furtherhamperingtheconductofmonetarypolicy.Inthiscase,thefailureofmonetarypolicyauthoritiestoaccountfortheseeffectswouldresultinapoorforecastoftheoutputgap,whichinturnwillleadtoasuboptimalpolicyoutcome. Monetarypolicytransmissionmayalsobeaffectedbyariseinstrandedassetsinintermediaries’balancesheetsandincreasedcreditrisks(NGFS2020).Medium-termeffectsoninflationexpectationsduetoachangingenergymix,incr
