Copyright Page
© 2022 International Monetary Fund
WP/22/207
IMF Working Paper
African and Monetary and Capital Markets Departments
How Persistent are Climate-Related Price Shocks? Implications for Monetary Policy
Prepared by Alain Kabundi, Montfort Mlachila, and Jiaxiong Yao*
November 2022
IMF Working Papers describe research in progress by the authors and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: Climate change is likely to lead to more frequent and more severe supply and demand shocks that will present a challenge to monetary policy formulation. The main objective of the paper is to investigate how climate shocks affect consumer prices in a broad range of countries over a long period using local projection methods. It finds that the impact of climate shocks on inflation depends on the type and intensity of shocks, country income level, and monetary policy regime. Specifically, droughts tend to have the highest overall positive impact on inflation, reflecting rising food prices. Interestingly, floods tend to have a dampening impact on inflation, pointing to the predominance of demand shocks in this case. Over the long run, the dominant monetary policy paradigm of flexible inflation targeting faced with supply-induced climate shocks may become increasingly ineffective, especially in LIDCs. More research is needed to find viable alternative monetary policy frameworks.
RECOMMENDED CITATION: Kabundi, Alain, Montfort Mlachila, and Jiaxiong Yao. 2022. “How Persistent are Climate-Related Price Shocks? Implications for Monetary Policy,” IMF Working Paper 22/207.
| JEL Classification Numbers: | E31, E50, E52, Q54 |
| Keywords: | climate change, monetary policy, monetary policy models |
| Author’s E-Mail Address: | akabundi@imf.org; mmlachila@imf.org; jyao@imf.org |
| JEL Classification Numbers: | E31, E50, E52, Q54 |
| Keywords: | climate change, monetary policy, monetary policy models |
| Author’s E-Mail Address: | akabundi@imf.org; mmlachila@imf.org; jyao@imf.org |
Contents
1. Introduction
2. Related Literature
3. Data and Stylized Facts
3.1 Data Sources and Transformations
Disasters
Temperature and Precipitation Shocks
3.2 Stylized Facts
4. Empirical Strategy
4.1 Methodology
4.2 Impact of Natural Disasters on Inflation
4.3 Impact of Climate Shocks on Inflation
Results
5. Conclusion
APPENDICES
A. Natural Disasters and Food Inflation at the Subnational Level
B. Results with Additional Control Variables
C. The Role of Food Inflation
D. The Impact of Floods on Food Production
E. Alternative Measure of Monetary Autonomy
F. Alternative Measure of Temperature and Precipitation
References
FIGURES
1. Frequency of Natural Disasters by Disaster Type
2. Frequency of Natural Disasters by Country Type
3. Temperature and Precipitation Z-Score Distribution
4. Response of Inflation to Natural Disaster Shock by Type and Intensity
5. Response of Inflation to Droughts, Floods, and Storms in AEs
6. Response of Inflation to Droughts, Floods, and Storms in EMs
7. Response of Inflation to Droughts, Floods, and Storms in LIDCs
8. Response of Inflation in AEs to Droughts, Floods, and Storms by IT-Regime
9. Response of Inflation in EMs to Droughts, Floods, and Storms by IT-Regime
10. Response of Food Price Inflation Droughts, Floods, and Storms
11. Impact of Climate Shocks on Inflation
12. Impact of Positive and Negative Climate Shocks on Inflation
13. Impact of Climate Shocks on Inflation: Role of Inflation Targeting
TABLES
1. Frequency Distributions of Natural Disaster by Type in Percentage of Total Observations
2. Summary Statistics of Inflation, Temperature and Precipitation (1970–2018)