Macro Insights Weekly: Climate inflation
- There are three kinds of climate inflation to consider
- First, natural disasters associated with global warming are increasingly causing food price shocks
- Second, green-tech like EV batteries and wind turbines are causing metals and minerals inflation
- Third, to help green transition, fossil fuel taxes and reg would rise, pushing up their prices
- Both fiscal and monetary policy would have to be calibrated for climate inflation
Commentary: Climate inflation
“There is a price to be paid for going green at a pace that reflects the dual objective of safeguarding both our planet and our right to self-determination.”-- Isabel Schnabel, Member of the Executive Board of the ECB, March 17,’22
Multiple inflation shocks are afflicting the global economy these days; there is Covid inflation, caused by supply chains being disrupted by stringency measures, goods demand surging for those in lockdown, and then services demand surging when the pandemic ebbs. Then there is conflict inflation, causing supply shortages of fuel and food. Supply/demand imbalances stemming from the pandemic and conflict are characterising the present inflation backdrop.
But these shocks are of largely short-term nature; surely the pandemic and the Ukraine war will end. But there are medium term structural factors are play too; China’s rapid aging may deprive the world of its previously plentiful workforce. Forces of deglobalisation at play may push for multiple and redundant supply chains, adding inefficiency and costs.
And above all this is climate inflation. Global climate change and climate mitigation-induced inflation would likely have far greater ramification in the medium and long-term than any of the other factors, in our view. Within climate inflation, we need to take cognizance of inflation related to climate change itself, and inflation related to the green transition process.
Impact of natural disasters and severe weather events on economic activity and prices is steepening. This year already has had several extreme droughts, which, in addition to the Ukraine war, has contributed to the ongoing jump in food prices around the world. Increasing frequency of floods and storms can also cause widespread crop failures.
There are two key aspects to green transition related inflation. First, going green can entail undertaking a brown process. For instance, most green technologies require significant amounts of metals and minerals, such as copper, lithium and cobalt. Producing an electric car can take up to six times more minerals than their internal combustion engine counterparts. An offshore wind energy plant requires over seven times the amount of copper compared with a gas-fired plant. As such transition is undertaken, prices of metals and minerals would likely rise.
Second, in order for green solutions to be acceptable to the market, they have to be subsidised initially; fossil-fuel usage would have to be taxed as well. A relative price adjustment, achieved through taxes and regulation, would entail higher prices of oil, gas, coal during the green transition phase; which would push up the energy part of the CPI basket.
We expect monetary and fiscal policy to become informed by the variety of climate inflation in the coming years. Should energy transition-related inflation be tolerated as a worthy expense toward going green? Can such inflation be readily separated from non-transition related inflation? What would be the forward guidance? Should central banks green their balance sheets; should their asset purchase programs shun brown bonds? These tough questions are going to receive plenty of attention from researchers and policy makers in the coming years and decades.
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