What are the implications of climate change, and climate change–related policies, for macroeconomics in general and monetary policy in particular? This is the key question debated at a recent symposium on “Climate Change: Implications for Macroeconomics” organized by the Applied Macroeconomics and Econometrics Center (AMEC) of the New York Fed on May 13. This post briefly summarizes the content of the discussion and provides links to recordings of the various sessions and the participants’ slides.
The goal of the Symposium was to have an open and lively discussion on the subject of climate change and its implications for macroeconomic policy. A group of academics and policymakers discussed and debated key topics split across four sessions: (1) the implications of climate change for monetary policy; (2) understanding the macroeconomic impacts (including distributional implications) of the reallocation of labor and capital across sectors and geographies that may arise due to climate change and climate policies; (3) examining the effect of climate policy on the global supply chain and corresponding implications for monetary policy; and (4) understanding the financial market impact of uncertainty associated with climate change and climate policies and the corresponding effects on the macroeconomy.
Implications of Climate Change for Monetary Policy
The first session focused on macroeconomics. James Stock from Harvard University discussed the implications of climate change for monetary policy (slides). The gist of his presentation was that climate change and policies designed to address it will be an important source of risks for macroeconomic management. Some of these risks arise from physical disruptions caused by climate-related events such as hurricanes or heat waves, but many arise from the effects of so-called transition policies—that is, policies meant to address climate change, such as a carbon tax. Professor Stock then provided empirical evidence on some of these risks, using studies that analyze the impact of carbon taxes, climate policy uncertainty, and energy prices on real activity and inflation.
Iván Werning from MIT also elaborated on the implication of transition risks for the macroeconomy (slides). Werning first discussed the effects of energy price shocks—such as those the U.S. economy is currently experiencing—in any economy where real wages do not adjust quickly, as in the work of Blanchard and Galí, and emphasized that in such an economy these shocks are akin to cost-push shocks, which have inflationary effects. He then covered the topic of monetary policy in times of structural reallocation, borrowing from his work with Guerrieri, Lorenzoni, and Straub, and argued that monetary policy may want to allow for some inflation in order to facilitate the adjustment in real wages and reallocation across sectors.
Labor and Capital Reallocation and Climate Change
Our second session focused on the implications of climate for labor and capital reallocation. Our first speaker, Daron Acemoglu of MIT, highlighted the need for improvements in energy efficiency, but also noted that the transition may be more or less difficult for certain “tasks” (slides). For example, there have been huge advances in renewable energy, especially solar and wind. He noted that part of the reason for the success in renewable energy is the price of alternatives: when alternative energy sources have been expensive, investment in green technology increased and vice versa. This suggests that any efforts to make gas cheaper will hinder progress in green energy technology. In terms of the effect on labor, Acemoglu commented that while it is possible that a full transition to clean energy can be very costly, many manufacturing firms have already transitioned to clean energy, and only 40,000 workers are currently employed in coal. Finally, Acemoglu argued that with standard discounting, welfare calculations based on utility maximization would imply that any climate damage in one hundred years would not matter at all, and he argued for an alternative method for thinking through the need for macroeconomic policy.
Our next speaker was Tatyana Deryugina from the University of Illinois at Urbana-Champaign. Professor Deryugina outlined the effects of climate change on the spatial distribution of labor (slides). First, she noted that there is a lot of scope for labor mobility in the U.S.; almost 40 percent of individuals live in places that are different from where they were born. To the extent that climate will change the distribution of productivity across space, these changes may be capitalized on by the mobility of labor. However, she also highlighted that people seem to move suboptimally; for example, Professor Deryugina cited her work on Hurricane Katrina, which demonstrated that those who had to move because of the hurricane ended up earning more after leaving New Orleans than those who stayed. She commented that this begs the question: why did they not leave in the first place? Finally, she highlighted that understanding why this suboptimal mobility is present (lack of information or social networks, for example) will be key for implementing policies that are conducive to mobility.
Climate Change, Trade, and Global Production
The third session turned to the global implications of climate change. The session’s speakers discussed how climate change may shift economic activity within, across, and between countries, and explored the associated implications for economic growth. The first speaker, Solomon Hsiang from the University of California, Berkeley, presented evidence on how temperature changes have impacted economic growth across countries, using historical data (slides). While the temperature changes have been gradual, Hsiang showed that small changes will have dramatic impact on the world. He then turned his attention to discussing the complexity in deriving accurate distributions of potential climate events.
The second speaker, Esteban Rossi-Hansberg from the University of Chicago, discussed the importance of adaptation to climate change (slides). His presentation focused on the heterogeneous impacts of climate change across locations, implying winners and losers. His quantitative modeling highlighted the need for spatial reallocation of economic activity and the associated costs and benefits. Rossi-Hansberg argued for the need for richer general equilibrium macroeconomic models of climate change to be able to better quantify the impact of and policies associated with climate change.
Climate Uncertainty and Financial Markets
The fourth and final session focused on uncertainty related to climate change and financial markets. Lars Peter Hansen of the University of Chicago discussed the policy challenges posed by climate change uncertainty (slides). He argued that historical measurement based on past climate change has limited value and that policies unsupported by credible quantitative modeling could harm the reputations of central banks. He posited that decision theory under uncertainty offers some good ideas on how to discuss and classify our discussions, since it allows for a broad perspective on uncertainty and includes formulations that are dynamic and recursive. As an example of ambiguity, Professor Hansen pointed to divergent climate model predictions—considering 144 models, he pointed out considerable divergence across the models and stated that it is not clear how to weigh these various models to get a probability distribution of the effect. Discussing tilting portfolios green, he pointed out that while there is some research that shows the benefit for green policy, there is also research that shows the benefit of doing otherwise.
Monika Piazzesi discussed the role of financial markets in the transition toward net zero (slides), which refers to a state where an equal amount of carbon dioxide is removed from the atmosphere as is released. She began her presentation by pointing to the massive shift in asset purchases with the rise in the share of ESG (environmental, social, and governance) investments. Focusing on the European Central Bank portfolio, she pointed out that it looks quite different from the European market portfolio. The ECB tends to buy bonds for manufacturing sectors with higher emissions, thus tilting its bond purchase toward dirtier sectors. The ECB portfolio also has a lower share of services compared to the European market portfolio, while the services sector has low carbon emissions. In the context of a growth model with climate externalities and financial frictions, she argued that central bank purchases cannot be market-neutral, implying that when central banks intervene, there will be an effect on capital allocation and the market price of risk. Thus, it is important to understand which way central bank purchases tilt, green versus brown.
In sum, the symposium explored some of the ways in which climate change has important implications for macroeconomics and monetary policy, and that therefore policymakers do want to take climate change into account when thinking about policy over the next decades.
Rajashri Chakrabarti is the head of Equitable Growth Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
Marco Del Negro is an economic research advisor in Macroeconomic and Monetary Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
Julian di Giovanni is the head of Climate Risk Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
Laura Pilossoph is an assistant professor of economics at Duke University.
How to cite this post:
Rajashri Chakrabarti, Marco Del Negro, Julian di Giovanni, and Laura Pilossoph, “Climate Change: Implications for Macroeconomics,” Federal Reserve Bank of New York Liberty Street Economics, July 7, 2022, https://libertystreeteconomics.newyorkfed.org/2022/07/climate-change-implications-for-macroeconomics/.
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).