Exploring the Environmental Impact of Monetary Policy

As climate change risks escalate, central banks are increasingly called upon to address this global challenge. Yet, estimates of the environmental impact of monetary policy are limited, leaving a significant gap in understanding how monetary policy interacts with climate change. In this paper, we aim to fill this gap by providing new evidence based on U.S. data. We identify monetary policy shocks using the recursiveness assumption and estimate their effects on domestic carbon dioxide emissions. Three key findings emerge from our analysis. First, an unexpected monetary policy tightening produces a persistent yet transitory negative effect on total CO2 emissions. This finding holds consistently across different model specifications, periods, and monetary policy indicators, underscoring its robustness. Second, the effects of monetary policy vary significantly across major polluter types. Emissions in the industrial sector, closely tied to production activities, show the strongest response. In contrast, emissions in the residential and commercial sectors are weakly affected, likely due to the essential nature of energy services. Finally, the contribution of U.S. monetary policy shocks to explaining domestic CO2 emissions fluctuations has been modest. Since central banks have limited capacity to directly influence environmental outcomes, monetary policy should be viewed as complementary to fiscal policy and environmental regulation in addressing climate change.