Climate change and monetary policy implications

Philip R. Lane, Member of the Executive Board of the ECB, delivered a keynote speech at the Climate, Nature and Monetary Policy Conference jointly organized by the ECB, the Centre for Economic Transition Expertise, and the Frankfurt School of Finance and Management.

The speech highlighted that global warming is no longer a distant threat, with 2023, 2024, and 2025 being the hottest years on record. Extreme weather events have increased in frequency and severity, causing substantial economic damage and accelerating planetary heating since the 1880s.

The European Union has committed to ambitious climate targets through the Fit for 55 package, aiming to reduce greenhouse gas emissions by at least 55% by 2030 and achieve climate neutrality by 2050. These policies contribute to global emission slowdown and enhance EU economic resilience.

Climate change and transition policies significantly impact output, inflation, asset prices, financial stability, and the transmission of monetary policy. The ECB has integrated climate considerations into its economic analysis, modeling, and forecasting, including the development of specialized macroeconomic models like the NAWM-E and DREAM.

Extreme weather events affect the euro area economy through disruptions in production, energy demand, and infrastructure, with long-term damages reducing potential output. The impact on inflation is observed in food prices, with heatwaves increasing food inflation and contributing to volatility. Future climate projections suggest more frequent shocks, with nonlinear effects and potential climate tipping points.

The green transition involves substantial investment, estimated between 2.7% and 3.7% of EU GDP annually until 2030, supported by programs like Next Generation EU. Surveys indicate that firms expect increased investment related to climate policies, especially during transition phases.

Modeling efforts, including scenario analysis and macroeconomic models, assess the impacts of transition policies, with findings indicating moderate effects on growth and inflation, but significant uncertainties remain. The ECB is advancing its models to better incorporate climate risks and policies.

Climate change influences monetary policy transmission through asset prices, bank lending conditions, and financial stability. Climate-related shocks can create trade-offs between supporting the economy and maintaining price stability, with policy responses needing to be data-dependent and case-specific.

The ECB has revised its monetary policy tools, including tilting asset purchases toward greener issuers and updating collateral frameworks to manage climate risks. These measures align with the ECB’s mandate to support economic policies and environmental protection.

In conclusion, climate change reduces potential output, increases economic volatility, and influences investment and inflation dynamics. The ECB emphasizes a data-driven approach to monetary policy, continuously integrating climate considerations into its analysis and operational frameworks amidst high uncertainty about future climate trajectories.