Climate change and monetary policy in the euro area

Work stream on climate change

Disclaimer While the content of this paper can be regarded as final, it has not been fully edited and formatted in line with the ECB's publication process. This preliminary version is being released for information ahead of the ECB Forum on Central Banking 2021 and will be replaced by a final version in due course.

Occasional Paper Series

Climate change and monetary policy in the euro area

No 271 / September 2021

Disclaimer: This paper constitutes staff input into the Governing Council's deliberation in the context of the ECB's monetary policy strategy review. This paper should not be reported as representing the views of the Eurosystem. The views expressed are those of the authors and do not necessarily reflect those of the Eurosystem.

Acknowledgements

This report has been jointly produced by the Eurosystem work stream on climate change and monetary policy comprising staff from the European Central Bank (ECB) and the national central banks (NCBs) of those countries that have adopted the euro. The report fed into the Governing Council's deliberations on the monetary policy strategy review 2020-21 but does not reflect the outcome of these deliberations.

The authors would like to thank Christophe Beuve, Dirk Broeders, Alessandro Calza, Siobhán Devin, Philipp Hartmann, Elke Heinle, Vesela Ivanova, Luc Laeven, Bettina Landau, Fernando Monar, Giulio Nicoletti, Gilles Noblet, Romana Peronaci, Marcin Przybyla, Imène Rahmouni-Rousseau, René Rollingswier, Massimo Rostagno, Philipp Rother, Torsti ("Toto") Silvonen, Frank Smets, João Sousa, Bram Van der Eem, Isabel Vansteenkiste, Gyorgy Varhelyi, Ralph Weidenfeller, Paul Wessels, Caroline Willeke, Chiara Zilioli, and participants in various presentations at the ECB's Monetary Policy Committee for their valuable comments, discussions, input and suggestions.

The authors are also grateful to Ursel Baumann, Annekatrin Bergmann, and Manfred Kremer for their support throughout the production and editorial process.

Hélène Gaston and Mariadolores Schiavone provided excellent research assistance. João Domingues Semeano provided data support for Chapter 2.

Co-leads of the work stream
Francesco Drudi	Emanuel Moench
European Central Bank	Deutsche Bundesbank
email: [e-mail]	email: [e-mail]
Cornelia Holthausen*	Pierre-François Weber
European Central Bank	Banque de France
email: [e-mail]	email: [e-mail]
(* from November 2020; until October 2020: Isabel Vansteenkiste)
Coordinators
Gianluigi Ferrucci	Ralph Setzer
European Central Bank	European Central Bank
email: [e-mail]	email: [e-mail]
Additional contributing authors
Bernardino Adao	Stéphane Dees (lead author of Section 2.4)
Banco de Portugal	Banque de France
Spyros Alogoskoufis	Mar Delgado Téllez
European Central Bank	Banco de España
Malin Andersson (co-lead author of Chapter 1)	Virginia Di Nino
European Central Bank	European Central Bank
Jana Aubrechtova (co-lead author of Sections 7.2 and 7.3)	Arturo Diez-Caballero
European Central Bank	European Central Bank
Aris Avgousti	Claudia Duarte (co-lead author of Sections 7.2 and 7.3)
Central Bank of Cyprus	European Central Bank
Francesca Barbiero	Ángel Estrada
European Central Bank	Banco de España
Lena Boneva	Donata Faccia
European Central Bank	European Central Bank
Andreas Breitenfellner	Ivan Faiella
Oesterreichische Nationalbank	Banca d'Italia
Giovanna Bua	Mátyás Farkas
European Central Bank	European Central Bank
Maurice Bun	Alessandro Ferrari
De Nederlandsche Bank	Banca d'Italia
Francesco Caprioli	Fabio Fornari
Banca d'Italia	European Central Bank
Matteo Ciccarelli (lead author of Chapter 3)	Alberto Fuertes Mendoza
European Central Bank	Banco de España
Matthieu Darracq Pariès	Pablo Garcia-Sanchez (co-lead author of Chapter 1)
European Central Bank	Banque centrale du Luxembourg

Alessandro Giovannini

European Central Bank

Patrick Grüning

Lietuvos bankas

Paolo Guarda

Banque centrale du Luxembourg

Gerbert Hebbink

De Nederlandsche Bank

Sarah Jane Hlásková Murphy (co-leadauthor of Chapter 6) European Central Bank

Michael Ioannidis (co-lead author of Chapter 6) European Central Bank

Lorenzo Isgro

European Central Bank

Daniel Kapp

European Central Bank

Mélissa Kasongo Kashama

Nationale Bank van België/Banque Nationale de Belgique

Paloma Lopez-Garcia

European Central Bank

Matija Lozej European Central Bank

Reamonn Lydon

Central Bank of Ireland

Otso Manninen

Suomen Pankki - Finlands Bank

Andres Manzanares

European Central Bank

Niall McInerney

Central Bank of Ireland

Christoph Meinerding

Deutsche Bundesbank

Katri Mikkonen

European Central Bank

Alessandro Mistretta

Banca d'Italia

Francesco Paolo Mongelli

European Central Bank

Carlos Montes-Galdon

European Central Bank

Georg Müller

European Central Bank

Carolin Nerlich (lead author of Sections 2.1 and 2.2) European Central Bank

Malgorzata Osiewicz

European Central Bank

Boris Osorno-Torres

European Central Bank

Jean-François Ouvrard

Banque de France

Adrian Page

European Central Bank

Niki Papadopoulou

Central Bank of Cyprus

Miles Parker (lead author of Chapter 4 and Section 5.5) European Central Bank

Filippos Petroulakis

Bank of Greece

Anamaria Piloiu

European Central Bank

Gašper Ploj

Bank of Slovenia

Wolfgang Pointner

Oesterreichische Nationalbank

Alexander Popov

European Central Bank

Doris Prammer

Oesterreichische Nationalbank

Ricardo Queiroz

European Central Bank

Omar Rachedi

Banco de España

Lavinia Rognone

European Central Bank

Oke Röhe

Deutsche Bundesbank

Madelaine Roos

European Central Bank

Simone Russo

Bank Ċentrali ta' Malta/Central Bank of Malta

Daniel Santabárbara

Banco de España

Guido Schotten

De Nederlandsche Bank

Beatriz Sotomayor

European Central Bank

Livio Stracca

European Central Bank

Fabio Tamburrini

European Central Bank

Anastasia Theofilakou

Bank of Greece

Pinelopi Tsalaporta

Bank of Greece

Jan Willem van den End

De Nederlandsche Bank

Lia Vaz Cruz

European Central Bank

Mark Andreas Weth

Deutsche Bundesbank

Gonzalo Yebes Gomez

European Central Bank

This report is part of a set of papers within the ECB's Occasional Paper Series, related to the ECB's Strategy review 2020-21. This set includes the following papers:

Set of Occasional Papers related to the ECB's Strategy review 2020-21

No 263, "The implications of globalisation for the ECB monetary policy strategy". No 264, "Inflation expectations and their role in Eurosystem forecasting".

No 265, "Inflation measurement and its assessment in the ECB's monetary policy strategy review". No 266, "Digitalisation: channels, impacts and implications for monetary policy in the euro area".

No 267, "Review of macroeconomic modelling in the Eurosystem: current practices and scope for improvement". No 268, "Key factors behind productivity trends in EU countries".

No 269, "The ECB's price stability framework: past experience, and current and future challenges".

No 270, "Non-bank financial intermediation in the euro area: implications for monetary policy transmission and key vulnerabilities". No 271, "Climate change and monetary policy in the euro area".

No 272, "The role of financial stability considerations in monetary policy and the interaction with macroprudential policy in the euro area".

No 273, "Monetary-fiscal policy interactions in the euro area".

No 274, "Clear, consistent and engaging: ECB monetary policy communication in a changing world". No 275, "Employment and the conduct of monetary policy in the euro area".

No 276, "The mandate of the ECB: Legal considerations in the ECB's monetary policy strategy review". No 277, "Evolution of the ECB's analytical framework".

No 278, "Assessing the efficacy, efficiency and potential side effects of the ECB's monetary policy instruments since 2014".

No 279, "The need for an inflation buffer in the ECB's price stability objective - the role of nominal rigidities and inflation differentials". No 280, "Understanding low inflation in the euro area from 2013 to 2019: cyclical and structural drivers".

Contents

Abstract		4
Executive summary	5
1	Economic implications of the physical risks of climate change	20
	1.1	Global warming	20
	1.2	Extreme weather events	26
	Box 1 International evidence of the impact of climate change on
		price stability	29
2	Climate policies and transition risks	32
	2.1	EU climate frameworks and EU policy initiatives	33
	2.2	The national policy mix to achieve climate targets	37
	2.3	Towards an enhanced policy mix	46
	2.4	The macroeconomic impact of mitigation policies	48
	Box 2 Implications of the COVID-19 pandemic for EU climate policy	56
	Box 3 Economic and environmental impact of introducing a carbon
		tax in Spain	57
	Box 4 The impact of a carbon tax on production costs across EU
		countries	59
3	Challenges for macroeconomic modelling	62
	3.1	Climate models and their use in economic frameworks	62
	3.2	Integrating climate risks into central bank workhorse models	67
	3.3	Implications for Eurosystem projections	72
	Box 5 Environmental dynamic stochastic general equilibrium
		models: specifications and selected applications	76
	Box 6 Predictions of a macro-financial model for the transition
		period from a low-carbon tax to the optimal carbon tax level	78
4	The impact of climate change on the financial system	81
	4.1	The potential impact of transition risk on financial institutions	82
	4.2	Pricing of physical and transition risks	83

ECB Occasional Paper Series No 271 / September 2021

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