The late arrival of the monsoon after a period of intense heat waves is likely to weigh on June inflation data when it is issued on Friday. Inflation for the month is likely to rise 5% year-on-year, higher than the trend expected earlier in the month, according to a senior economist at a global bank. Climatic factors are playing an increasingly key role in influencing food and fuel inflation, which tends to impact overall inflation levels, creating a new area of concern for policymakers. Gayatri Nayak explains how climate change can impact monetary policy:
How have climatic factors affected prices in India?
In India, the erratic progress of monsoons has had an impact on food and agricultural product prices from time to time. But seldom has one witnessed a price rise due to other weather conditions. However, heatwaves in many parts of the country have impacted vegetable supplies to major markets. Prices of essential vegetables such as tomatoes, potatoes, coriander, onion, cucumber and green chilli have surged by 25-100% in June, according to market estimates.
Does climate change impact monetary policy?
Yes. There are different channels through which climate change can affect monetary policy. The Reserve Bank of India’s latest monetary policy report has some details. First, climate change directly impacts inflation through adverse weather events affecting farm output and global supply chains. Second, climate change could impact the natural rate of interest due to increasing temperatures and the occurrence of extreme weather events undermining productivity and lowering potential output. Thirdly, the aftereffects of climate change might weaken the transmission of monetary policy actions to financing conditions faced by households and firms. For these reasons, central banks are increasingly incorporating climate risks into their modelling frameworks.
Why should central banks be concerned?
In contrast to demand-driven inflation where monetary policy is relevant to manage demand over the business cycle and stabilise prices, supply shocks are caused by changes in the availability or production costs of goods and services, said an International Monetary Fund (IMF) working paper on the topic released in April. As a result, central banks may have limited control over the underlying factors driving supply shocks, making it difficult to achieve price stability. In the case of food price shocks caused by climate change, central banks may face a dilemma between stabilising inflation and supporting economic activity. In fact, tightening monetary policy to contain inflation could exacerbate the negative impact of supply shocks on growth and employment.
What is the RBI’s stand?
The recent Financial Stability Report has also flagged concerns about climate change as one of the risky areas faced by the global financial system. The continuing effect of monetary policy action and stance is keeping core inflation muted. Spillovers from geopolitical hostilities, volatile international financial markets and climate shocks are key risks to growth and inflation outlook, the central bank said in its latest monetary policy report.
How are central banks dealing with it globally?
Central banks from Latin America to North America to Europe and Asia, and multilateral agencies such as the IMF and global organisations such as the World Economic Forum have been voicing their concerns about the impact of climate change on monetary policy through food and fuel prices. Many central banks including the European Central Bank are deferring rate cuts due to climate-induced inflation concerns.
