The Unassuming Economist

From a speech by Benoît Cœuré, Member of the Executive Board of the European Central Bank:

“2018 has seen one of the hottest summers in Europe since weather records began.^[1]Increasing weather extremes, rising sea levels and Arctic melting are now clearly visible consequences of human-induced warming.^[2] Climate change is not a theory. It is a fact.

While only one dimension of the human cost, the consequences in macroeconomic terms look set to be large. Without further mitigation, cumulative emissions pose significant risks of economic disruption.^[3]

While there is a wide recognition that environmental externalities should be primarily corrected by first-best policies, such as taxes^[4], all authorities, including the ECB, need to reflect on, and consider, the appropriate response to climate change.

In recent years, central bankers, led by Bank of England Governor Mark Carney, have started discussing the financial stability implications of climate change.^[5] The first tangible results are trickling in. The Financial Stability Board’s Task Force on Climate-related Financial Disclosures published its first status report just a few weeks ago. Only last week, ECB Banking Supervision communicated to banks that climate-related risks have been identified as being among the key risk drivers affecting the euro area banking system.

And, of course, the Central Banks and Supervisors Network for Greening the Financial System published its first progress report just a few weeks ago, reasserting that climate-related risks fall squarely within the supervisory and financial stability mandates of central banks and supervisors.

An area that has received less attention though, both in policy and in academia, is the impact of climate change on the conduct of monetary policy. Today I would like to contribute to this debate and offer a way of thinking about how climate change fits into our current monetary policy framework – the way we react to shocks and the way we think policy propagates through the economy – and how it may affect our monetary policy implementation.

I will argue that climate change can be expected to affect monetary policy one way or the other. That is, if left unchecked, it may further complicate the correct identification of shocks relevant for the medium-term inflation outlook, it may increase the likelihood of extreme events and hence erode central banks’ conventional policy space more often, and it may raise the number of occasions on which central banks face a trade-off forcing them to prioritise stable prices over output.

In the more desirable scenario in which humankind rises to the climate change challenge, the implications for monetary policy could be equally far-reaching, in particular if the associated shift in the energy mix changes relative prices to an extent that risks destabilising medium-term inflation expectations.

I will also argue that there is scope for central banks themselves to play a supporting role in mitigating the risks associated with climate change while staying within our mandate.”

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