Monetary Policy Design with Recurrent Climate Shocks
IMF Working Papers, November 24, 2023
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- Monetary Policy Design with Recurrent Climate Shocks
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Bibliographic details
- Authors: Vimal V Thakoor, Engin Kara
- Published: November 24, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400257261.001
Summary
- As climate change intensifies, the frequency and severity of climate-induced disasters are expected to escalate.
- The paper develops a New Keynesian Dynamic Stochastic General Equilibrium model to analyze the impact of these events on monetary policy.
- Disasters are conceptualized as left-tail productivity shocks with a quantified likelihood, leading to a skewed distribution of outcomes.
- This skewness creates a trade-off for central banks between increased inflation risks and reduced output.
- Results suggest modifying the Taylor rule to give equal weight to responses to both inflation and output growth, indicating a gradual approach to climate-exacerbated economic fluctuations.
Model and analytical framework
- Model type: New Keynesian Dynamic Stochastic General Equilibrium model.
- Shock characterization: climate-induced disasters modeled as left-tail productivity shocks with a quantified likelihood producing a skewed distribution of outcomes.
- Core trade-off identified: higher inflation risk versus lower output following climate shocks.
Key findings
- Central banks face a significant policy trade-off when climate-induced disasters increase the skewness of economic outcomes.
- Optimal adjustment: modifying the Taylor rule to give equal weight to inflation and output growth responses.
- Recommended policy approach: gradual responses to climate-exacerbated economic fluctuations rather than abrupt policy shifts.
Policy recommendations
- Adapt monetary policy rules to account for recurrent, left-tail productivity shocks from climate events.
- Weight inflation stabilization and output stabilization equally within policy rules (Taylor rule modification).
- Pursue gradual policy adjustments to manage the increased skewness and uncertainty introduced by climate shocks.
Keywords and subjects emphasized
- Subject: Inflation, Inflation targeting, Monetary policy, Prices, Production, Productivity, Public debt
- Keywords: Climate change, fiscal policy, Inflation, inflation coefficient, inflation response, inflation stabilization, Inflation targeting, monetary policy, monetary policy design, output stability, Productivity, skewness curve, Taylor rule
Vimal V Thakoor, and Engin Kara. "Monetary Policy Design with Recurrent Climate Shocks", IMF Working Papers 2023, 243 (2023), accessed 9/11/2026, https://doi.org/10.5089/9798400257261.001
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