Climate and monetary policy: do temperature shocks lead to inflationary pressures?

In the race towards economic growth, increased pollutant emissions have spurred the rise in global surface temperatures, intensifying the process of climate change. While the existing literature on the economic impact of climate-related variables has looked at outcomes such as growth, income, fiscal response, and poverty, the effect of temperature shocks on inflation has largely been neglected. This paper is an attempt to fill this lacuna. Indeed, we analyze the dynamic impact of temperature shocks on inflation, a key policy variable of most central banks. We use a panel-VAR method with fixed-effects and a sample of developed and developing countries over the period 1961–2014. Our results suggest that temperature shocks lead to inflationary pressures. Worryingly, and for developing countries in particular, we find that these effects persist several years after the initial shock. Our finding remained unaltered by various robustness checks. We show that these effects pose a threat to monetary policy making. We argue that central banks should pay more attention to temperature shocks.