Climate Change and the Transmission of Macroeconomic Shocks

Climate change results in a gradual rise in global average temperatures and, according to Glocker and Url, should therefore be modelled in economic analysis as structural change rather than as an exogenous weather event.

Accordingly, the authors expect that climate change will primarily alter the transmission of traditional macroeconomic shocks to the economy, and that unexpected weather events will have secondary effects by comparison.

Glocker and Url developed a theoretical DSGE model in which positive temperature anomalies dampen total factor productivity and thus increase the slope of the Phillips curve. This leads to an amplification of the price effects of demand shocks and a dampening of the output response. Their empirical analysis supports this conclusion. It is noteworthy that there is no evidence to suggest that temperature anomalies influence the price and output responses to supply shocks. This distinction confirms the hypothesis that temperature anomalies alter the slope of the Phillips curve and thereby influence the transmission of demand shocks, but not that of supply shocks.

"We show that even a small rise in average surface temperatures has a measurable impact on the transmission of demand shocks. For example, in a scenario involving global warming of +1 °C, demand shocks have a 20 percent greater impact on inflation, whilst the response in output is around 15 percent lower," so Christian Glocker and Thomas Url.

In an environment characterised by rising temperatures, expansionary fiscal policy measures designed to counteract a reduction in aggregate demand could prove to be of limited effectiveness. As temperature anomalies increase, such interventions could lead to significant price fluctuations without having any appreciable impact on the real economy. Furthermore, the findings suggest that monetary policy may become more effective at stabilising prices, whilst contributing less to stabilising output.