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Global temperatures and inflation: More volatile, less homogeneous inflation pressures across countries
Climate change can cause large economic disruptions by introducing new risks to supply chains and changing demand patterns. This economic memo explores how climate change, via its impact on global temperatures, transmits to inflation in Europe, with a country-specific focus on Denmark, Norway and Spain. The results indicate that global temperature shocks primarily affect inflation through energy, food and service price channels. The impacts vary across countries, indicating that warmer countries tend to face higher inflationary pressures, while colder countries experience deflationary pressures. Awareness of these heterogeneous effects is important for central banks in safeguarding price stability.
Key messages
Why is this important?
Central banks are tasked with ensuring price stability, which can be influenced by more frequent and extreme weather events. Understanding how these factors transmit to consumer prices and thereby inflation is essential for maintaining inflation targets and formulating effective monetary policy. If extreme weather events increase inflation volatility, it may require central banks to act.
Main chart
A global temperature shock affects inflation differently across countries
Note:
The chart shows impulse responses of headline inflation in Denmark, Norway and Spain (solid lines), expressed as percentage changes, to a 1°C global temperature shock. The global temperature shock is estimated following the approach used in Hamilton (2018) and has been linearly scaled to match a 1˚ C change to ease interpretation, aligning with established methods. Standard errors are calculated using Newey–West standard errors.
Source:
Own calculations.
“If we do not account for the impact of climate change on our economy, we risk missing a crucial part in our work to keep prices stable.”
Christine Lagarde, 2022
President of the European Central Bank