Climate change threatens to increase supply side shocks and accelerate inflation globally

The Jackson Hole Economic Symposium discussed the long-term challenges of central banks. These include productivity development, supply chain problems and rising debt levels. These structural changes in economy will be major due to, e.g., demographic changes (aging population) and climate change.

Climate change is a global supply side shock, but it is still unclear where and when its effects will be felt. So, the shock is non-linear. In any case, it is expected to

1) impact the availability of food and raw materials. Extreme weather conditions reduce food production and, at least temporarily, increase inflation in countries dependent on imported food. According to one study, the exogenous shock to international commodity prices accounted for 30% of euro area inflation volatility. As a result of these phenomena, inflation is expected to be more volatile and somewhat faster. It could be said that the current 2% inflation target will be the floor, having been the cap in past years. In addition, the numbers fluctuate a lot as a result of shocks.

2) make international trade more difficult. This is reflected as problems in supply chains. In addition, e.g., logistics risks grow in areas where there are extreme weather events.

3) weaken the infrastructure. This is concretely reflected in direct damage from extreme events on buildings, bridges and roads. The costs of natural disasters can be direct or indirect. Direct costs are related to immediate and short-term damage. Indirect costs, on the other hand, are overall economic and long-term costs caused by direct costs (such as production interruptions, substitution effect in production, demand for reconstruction). Naturally, the latter are more difficult to observe.

4) reduce labor productivity, which is particularly reflected in the impact of extreme temperatures on health and functional ability. Studies have already been carried out on this and the following observation has been made: when the temperature rises above 15 C, every one degree increase reduces labor productivity by 2%. If the temperature clearly rises from current levels, the impact on outdoor workers in particular may be extensive.

5) increase economic inequalities. Higher income countries suffer more direct losses in natural disasters, but have lower long-term indirect losses, i.e. the impact on GDP, employment and productivity is smaller. There is a simple explanation: in rich countries, the building stock is more valuable, but on the other hand, the economy is more resilient to shocks, preparedness is better and health care is more advanced than in lower-income economies. For example, in the Philippines, the most storm-prone region in the world, tropical storms reduced average household income by 6.6% in the short term. For the poorest households, income loss was permanent. In the US, the average impact of hurricanes on per capita income was only 0.45 percentage points.

The article is based on, e.g., this research paper.