Published: 4 May 2022
New risks for the economy – new challenges for monetary policy
Climate change entails new types of risk for the economy that monetary policy needs to take into account in order to maintain the objective of price stability. According to the IPCC’s latest report of 2021, extreme weather is expected to become more common as global average temperatures rise. This means more heatwaves, storms and weather disasters such as forest fires and floods. The effects of extreme weather are liable to harm people’s welfare and the production possibilites of companies. From a monetary policy perspective, the fluctuations in prices and output risk becoming larger.
Political decisions on raised taxes on CO₂ emissions or increased prices for emission rights in the transition to a less fossil-based economy may lead to some sectors of the economy becoming unprofitable and to prices for energy, for example, rising. Monetary policy does not aim to influence prices of individual goods such as energy. However, if rising energy prices were to find their way more permanently into the inflation process, monetary policy might have to consider this. The transition to a less fossil-based economy can thus affect both inflation and output.
The Riksbank’s monetary policy work on climate-related risks
The Riksbank participates in the global Network for Greening the Financial System (NGFS), which works to ensure that financial undertakings and authorities integrate climate and environmental risks into their work. Read more about the NGFS in section 2.5 on international cooperation. In the summer of 2021, the NGFS published several scenarios for how climate change may affect economic developments. The Riksbank has presented an overview of these scenarios in an Economic Commentary focusing on global and Swedish developments. E. Bylund and M. Jonsson (2021), “An overview of the economic consequences of the NGFS climate scenarios”, Economic Commentaries, No. 14, Sveriges Riksbank. According to the scenarios, economic costs are relatively small in terms of reduced GDP on a global level, which is in line with previous studies. This also applies to Sweden, where the costs are even smaller. The calculations have taken the costs of extreme weather and the climate transition into account. However, the risk of tipping points, which may involve considerable costs in all scenarios, has not been taken into account.
The risks of climate change imply that the economic developments will become more uncertain and that the likelihood of natural disasters will increase. Regarding this, the Riksbank has published a study investigating how climate change may affect the long-term real interest rate. E. Bylund and M. Jonsson (2020), “How does climate change affect the long-term real interest rate?”, Economic Commentaries, No. 11, Sveriges Riksbank. According to the study, greater uncertainty about economic developments and increased risks of natural disasters may lead to a lower long-term real interest rate. Monetary policy does not affect the long-term real interest rate. Instead, this interest rate is determined by other factors in the economy. Nevertheless, in order for the inflation target to be met, the policy rate needs to take changes in the long-term real interest rate into account. The study does not address the adjustment of the long-term real interest rate to a new long-term equilibrium. Such an analysis is more complex and is an important area for future research.
In an ongoing project, the Riksbank is studying how changes in the weather can affect variations in prices and output in Sweden. The study uses historical weather data to study the relationships between rising temperature, prices and output. The Riksbank will publish the results of the study in 2022.