Prices on a warming planet - the inflationary effects of climate change

Climate change is no longer a distant threat. Its adverse impacts on both human societies and natural ecosystems are already unfolding across the world. 2023 was the warmest year on record by a clear margin, and records were broken for ocean heat, sea level rise and glacier retreat. The multifaceted nature of these impacts is evident through droughts, forest fires, excessive precipitation, floods, heatwaves, hurricanes, intense frost periods, and weather that defies seasonal patterns. 

These events have become a source of supply-side shocks, emerging as an important risk to price stability around the world. In the past, supply-driven price shocks from extreme weather events tended to be isolated, relatively less frequent, and limited to specific goods or commodities. They would have only a muted and temporary impact on inflation rates. However, when several severe weather events converge, or one occurs with exceptional intensity, the resulting supply shock can be substantial enough to temporarily push inflation up beyond targeted levels. 

Aside from supply shocks, there are also other channels through which climate change can raise prices. These include trade disruptions and policy spillovers that have differential impacts across countries and regions. Climate change can also contribute towards greater price volatility. Such outcomes can be seen in many countries, but some - including those where agriculture is a significant part of the economy, or those who are net food importers - are more vulnerable. 

In addition, climate-related shocks may impact central banks’ ability to achieve their price stability mandate, as well as contributing to financial instability, and potentially affecting market interest rates. This challenges the effectiveness of conventional monetary policy. Stabilizing prices in the face of increasingly severe climate-related shocks requires greater policy coordination and a re-appraisal of conventional monetary arrangements.  

Learn more in the July Monthly Briefing of the World Economic Situation and Prospects, available on 2 July 2024.

Photo credit: Md. Hasanuzzaman Himel on Unsplash