Climate change risk to price stability: Higher average temperatures increase inflation
Increased average temperatures could drive up annual food and headline inflation by up to 1.18 percent by 2035, a new ECB working paper with PIK expertise shows. This effect persists over 12 months in rich and poor countries alike, making climate change an important economic factor for price stability.
In the study, the scientists looked at how climate indices – like high temperatures, extreme rainfall etc – have impacted inflation in historical data. They used these historical climate impacts on inflation to then assess the risks under future climate change without any adaption measures.“We find that the inflation response to average monthly temperature increases is non-linear. That means inflation goes up when temperatures rise, and it does so most strongly in summer and in hot regions at lower latitudes, for example the global south,” says Maximilian Kotz, scientist at the Potsdam Institute for Climate Impact Research PIK and first author of the European Central Bank (ECB) research paper.
The researchers also looked at the 2022 summer in Europe where heat and drought had a wide-spread impact on agriculture and the economy: “Using our results, we estimate that the 2022 summer heat extreme increased food inflation in Europe by about 0.6 percent. Future warming projected for 2035 would amplify the impacts of such extremes by 50 percent,” explains Kotz. “These effects are very relevant for currency unions with a two percent inflation target such as the Euro zone, and will continue to increase with future global warming.”
In the future, if governments do not strengthen their mitigation and adaption efforts, extremely hot summers could therefore pose an increasing risk to inflation and price stability.