Climate change-induced weather shocks pose challenges to monetary policy and pose downside risks to economic growth.

Global average temperatures are on the rise, with an accompanying increase in extreme weather events (EWE), and the economic and social impact of global warming is becoming increasingly evident.

According to the RBI’s Monetary Policy Report – April 2024., climate change-related weather shocks are posing downside risks to economic growth and challenges for monetary policy.

Climate change can significantly impact monetary policy in various ways. For one, it has increased the frequency and intensity of weather shocks, creating challenges for monetary policy.

Unfavorable weather events that affect agricultural production and global supply chains have a direct impact on inflation. Additionally, climate change may affect the natural rate of interest, and its aftereffects may lessen the ability of monetary policy actions to influence the financing conditions that businesses and households face.

The RBI warned that a decrease in productivity could lead to a decrease in the natural interest rate, but inflation shocks will require tighter monetary policy. Although central banks are increasingly incorporating climate risks into their modeling frameworks due to the increasing global climate change threat.

In comparison to a scenario without climate change, the report warned that long-term output could be reduced by about 9% by 2050 if climate mitigation policies are not implemented. The natural interest rate may decline as a result of this productivity decline, but tighter monetary policy may still be required in response to frequent inflation shocks. The report also emphasized that adverse weather events brought on by climate change present risks to the baseline growth trajectory.