Climate Change and Economic Dynamics: Temperature-dependent Shock Propagation

The gradual transition between different climate states, as evidenced by the smooth rise in temperatures, motivates conceptualizing climate change as a phenomenon influencing the propagation mechanism of traditional macroeconomic shocks, rather than as an independent shock. We formalize this idea through a theoretical model, which shows that climate change induces a structural shift in the economy by steepening the aggregate supply curve, thereby exacerbating the price effects of demand shocks while dampening the output response. Our empirical evidence is consistent with this prediction: higher temperatures raise the share of inflation variation attributable to demand shocks by up to 10 percentage points, underscoring the role of climate change in intensifying stagflationary dynamics rather than independently driving business cycle fluctuations.