Projects: TOOLBOX

Inflation and climate change: the role of climate variables in inflation forecasting and macro modelling

Climate change is increasingly affecting the objective, conduct and transmission of monetary policy. Yet, climate-related shocks and trends are still generally absent from the canonical models used by central banks for their policy analysis and forecasting. This briefing paper reviews the potential pitfalls of using a modelling framework that omits climate-related information and provides some reflections on how central banks can integrate climate change considerations into their ‘workhorse’ models.

This includes: accounting for an explicit role of the energy sector in the production structure and for specific climate change policies; improving the ability of models to cope with various sources of heterogeneity; and incorporating a more realistic representation of the financial sector, to analyse the possible stranding of assets and impairments in the transmission mechanism of monetary policy. It argues that a ‘suite-of-models’ strategy is a promising approach for central banks to cope with the climate challenge when designing a new generation of models.

To complement theory with practice, several examples of central banks that have already integrated climate-related information into their analytical frameworks are provided. The paper concludes with some specific recommendations.

 

This paper is part of a toolbox designed to support central bankers and financial supervisors in calibrating monetary, prudential and other instruments in accordance with sustainability goals, as they address the ramifications of climate change and other environmental challenges. The papers have been written and peer-reviewed by leading experts from academia, think tanks and central banks and are based on cutting-edge research, drawing from best practice in central banking and supervision.

A Toolbox of Sustainable Crisis Response Measures for Central Banks and Supervisors – Second Edition: Lessons from Practice

The second in a two-part series published in 2020, this report is designed to provide central banks and financial supervisors with an empirically based toolbox of options to align their crisis response measures with climate and sustainability objectives and mitigate potential sustainability risks.

The first edition was published in June 2020. This second edition significantly expands the empirical assessment of the COVID-19 crisis response of central banks and supervisors globally and examines how far central banks are incorporating climate and other environmental factors into their COVID-19 strategies and wider operations.

The core finding of the updated report is that there is currently a divergence between crisis response measures and wider efforts to promote sustainable finance. So far, less than 1 per cent of central banks and supervisors from 188 economies have directly connected their crisis response with sustainability factors.

The Toolbox part of the paper presents the policy tools available to central banks and financial supervisors, distinguishing between conventional (often sustainability-blind) measures and those that are sustainability-enhanced, in other words they take climate and wider sustainable development factors into account. The authors present nine different types of tools, grouped in three broad areas: monetary policy, financial stability, and ‘other’.

The paper also lists the responses to the COVID-19 crisis taken to date by monetary and financial authorities in 188 countries (as of 5 October 2020).

The authors conclude that central banks and supervisors should now work to overcome the gap between their strategic commitment to climate action and the delivery of crisis response measures. Practical steps include the development of agreed sustainability classifications that can be applied to calibrate their crisis interventions, and updating core conventions such as the ‘market neutrality’ principle. In future research, they will investigate the technical and regional implementation details of our four priority actions.

A Toolbox of Sustainable Crisis Response Measures for Central Banks and Supervisors

The first in a two-part series published in 2020, this report is designed to provide central banks and financial supervisors with options to align their crisis response measures with sustainability goals.

Central banks and financial supervisors are playing a crucial role in shaping the responses to the crisis brought about by the COVID-19 pandemic. To avoid lock-in to a high-carbon recovery and to fulfil their mandates for financial stability, central banks and supervisors need to align their COVID-19 response measures with the Paris Agreement on climate change. This new guide provides a framework for doing so.

The guide has been designed to help ensure that climate risks are accurately reflected in central banks’ balance sheets and operations, to minimize climate-related risks for regulated financial institutions, and to support governments’ efforts to scale up sustainable finance in line with the Paris Agreement and the Sustainable Development Goals. It is produced by the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science (LSE) and the Centre for Sustainable Finance at SOAS, University of London.