The Unassuming Economist

From a paper by David Barmes, Irene Claeys, Simon Dikau and Luiz Awazu Pereira da Silva:

“Central banks have made significant progress on incorporating climate risks into their monetary policy frameworks to address the economic and financial challenges posed by climate change. Key developments include conducting climate scenario analyses to evaluate the financial system’s resilience to climate-related risks, exploring how climate change affects price stability and monetary policy transmission, integrating climate variables into forecasting frameworks, fostering collaboration through initiatives like the Network for Greening the Financial System (NGFS) and, in some cases, integrating sustainability considerations into monetary operations such as collateral frameworks and quantitative easing programmes. Despite this progress, a critical area remains underexplored: the challenges that inflation-targeting central banks may face if confronted with more frequent, persistent and severe climate-related supply shocks.

Unlike demand shocks, supply shocks create trade-offs for central banks and, unlike transitory supply shocks, persistent supply shocks can lead to a systematic and prolonged overshooting of inflation targets and undermine long-term macroeconomic stability. A small number of senior figures in the central banking community have recently begun to highlight the risks of a future of intensified supply-side volatility (Brainard, 2022; Schnabel, 2023; Maechler, 2024; Bénassy-Quéré, 2024). Building on these analyses, this report aims to spark a policy discussion on adaptive inflation targeting, with a view to equipping central banks with a framework, analysis and toolkit that enables them to better navigate these supply-side disruptions. To maintain credibility and ensure the smooth implementation of possible changes to existing inflation-targeting regimes, central banks must communicate these changes clearly in times of relative stability when inflation is at or around target.”