On November 8, 2018 Benoît Cœuré, Member of the Executive Board of the ECB, at a conference on “Scaling up Green Finance: The Role of Central Banks”, organised by the Network for Greening the Financial System, the Deutsche Bundesbank and the Council on Economic Policies, in Berlin, held a speech on the effects of climate change on monetary policy

He described a scenario in which both the private and the public sector fail to take prompt action to cut CO2 emissions in line with the COP21 commitments and where “climate change is likely to affect the conduct of monetary policy in three important ways:

The first relates to our ability to correctly identify the shocks hitting the economy.

In recent years, for example, we have repeatedly observed an unusual blip in economic activity in the United States in the first quarter. This has often been attributed to a harsh winter, despite best efforts to seasonally adjust the data.

But causality is inherently difficult to establish. Indeed, statistical analysis has challenged the hypothesis that cold temperatures are behind the observed deceleration in first-quarter growth.^[9]

Similarly, last month, we saw a puzzling persistence in petroleum prices in Germany despite a parallel fall in oil prices. One hypothesis is that this year’s hot summer caused the water levels in German rivers to fall to levels that only allow petrol tankers to carry half their capacity, creating supply bottlenecks.

Uncertainty also extends to the effects of regulatory responses by governments to the growing challenges posed by climate change. German growth in the third quarter is currently projected to have stalled or even contracted, probably largely due to bottlenecks in the testing process under the new Worldwide Harmonised Light Vehicles Test Procedure.

But we cannot be sure. Given the current global environment, growth may have slowed for other reasons. Or the recent emission scandal may have led to a more fundamental shift in consumer preferences.

All this means that, to the extent that climate change can be expected to amplify the frequency of adverse weather shocks, and evidence to this effect is mounting, it will become increasingly difficult for central banks to disentangle the variation in the data relevant for the assessment of the medium-term inflation outlook.^[10] It will cause the signal-to-noise ratio to deteriorate and thereby increase the risk that central banks take action when in fact they shouldn’t, or vice versa.

The second implication relates to the distribution of shocks.

Put simply, the longer the risks of climate change are ignored, the higher the risks of catastrophic events, possibly with irreversible consequences for the economy. In other words, the distribution of shocks may become more “fat-tailed”.^[11]

This raises one question and one concern for monetary policy. The question is whether central banks themselves should hedge against such tail risks by taking pre-emptive measures. I will turn to this in the second part of my remarks.

The concern is that monetary policy may be more often forced to adopt non-standard policy measures. The global financial crisis has shown that extreme events can quickly erode central banks’ conventional policy space. Catastrophic climate change could thus test the limits of how far monetary policy can go and, in the extreme, force us to rethink our current policy framework.

The third and final implication relates to the persistence of shocks and the inflation-output trade-off central banks may face.

Climate change, for example, will make some areas of the world less habitable, which can be expected to increase the frequency and intensity of international migration.^[12]The events of recent years, though different in nature, highlight how migration can have long-lasting effects on broader labour market dynamics and, ultimately, wage developments.^[13] There is evidence that migration has contributed to dampening wage growth in Germany in recent years, thereby further complicating our efforts to bring inflation back to levels closer to 2%.^[14]

Similarly, in the absence of clear and tangible evidence that the demand for fossil fuels will decline, and with existing conventional oil fields depleting rapidly, persistent energy shocks cannot be ruled out.^[15″