Inflation and climate change: the role of climate variables in inflation forecasting and macro modelling

Boneva, Lena and Ferrucci, Gianluigi (2022) Inflation and climate change: the role of climate variables in inflation forecasting and macro modelling. The Inspire Sustainable Central Banking Toolbox Policy Briefing Papers (1). Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science, London, UK.

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Abstract

Climate change is increasingly affecting the objective, conduct and transmission of monetary policy. Yet, climate-related shocks and trends are still generally absent from the canonical models used by central banks for their policy analysis and forecasting. This briefing paper reviews the potential pitfalls of using a modelling framework that omits climate-related information and provides some reflections on how central banks can integrate climate change considerations into their ‘workhorse’ models. This includes: accounting for an explicit role of the energy sector in the production structure and for specific climate change policies; improving the ability of models to cope with various sources of heterogeneity; and incorporating a more realistic representation of the financial sector, to analyse the possible stranding of assets and impairments in the transmission mechanism of monetary policy. It argues that a ‘suite-of-models’ strategy is a promising approach for central banks to cope with the climate challenge when designing a new generation of models. To complement theory with practice, several examples of central banks that have already integrated climate-related information into their analytical frameworks are provided. The paper concludes with some specific recommendations.

Item Type:	Monograph (Report)
Official URL:	https://www.inspiregreenfinance.org/publications/
Additional Information:	© 2022 The Authors
Divisions:	LSE
Subjects:	G Geography. Anthropology. Recreation > GE Environmental Sciences H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
Date Deposited:	11 Jul 2022 13:51
Last Modified:	15 Sep 2023 22:36
URI:	http://eprints.lse.ac.uk/id/eprint/115533

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