Growing uncertainty posed by climate change could make it harder for central banks to manage inflation, and may force the Reserve Bank of Australia to reassess how it controls inflation in the future, incoming governor Michele Bullock says.
Delivering the annual Sir Leslie Melville Lecture at the Australian National University in Canberra, Ms Bullock discussed the implications of climate change and how it would affect Australia’s central bank and its objectives.
Ms Bullock said the RBA, like most central banks in the world, was used to navigating uncertainty, but the uncertainty posed by climate change is “particularly acute” because the bank is unable to accurately predict how it will affect the economy and financial system.
“These climate risks will affect the economy through several channels,” she said in her last speech as deputy RBA governor.
“Hotter temperatures and more extreme weather will disrupt businesses, damage property and lower productivity growth. Actions taken to reduce emissions may present adjustment costs, but they will also present opportunities.
“Indeed, while there is much uncertainty in this area, there is general agreement that a timely and orderly transition will be the less costly approach in the long run.”
The long run, she said, would include how the RBA approaches monetary policy — that is, how it controls outbreaks of inflation.
“This is because climate change might have important effects on an economy’s capacity to produce goods and services,” she said.
“It might also affect the neutral interest rate and, therefore, the stance of monetary policy.”
That stance could involve re-examining the RBA’s goal of keeping inflation between a flexible target range of 2 to 3 per cent.
“The RBA Review considered this question but found that flexible inflation targeting had served the Bank well and recommended its continued use.
“Nevertheless, I expect that debate will continue.”
How climate change will affect inflation
Repeatedly citing the unpredictability of climate change and its impacts, Ms Bullock described how more severe and extreme weather events would affect the Australian economy.
In the short-term, bushfires, floods and other natural disasters could lead to a supply shortage for products, leading to supply shocks and driving up prices until conditions improve and production returns.
“However, if these disruptions become more frequent, severe or protracted due to climate change, prices could become more volatile, or if there are persistent adverse effects on productive capacity, remain higher for longer,” she said.
“The longer inflation is allowed to remain high, the greater the risk that expectations will drift higher, and the greater the real economic costs will be of bringing inflation back down.”
She warned that extreme weather could also see lower levels of investment or household spending, and although that could rebound should infrastructure or homes need to be rebuilt, it could divert investment away from “potentially more productive opportunities”.
Extreme weather events could also lower unemployment if physical assets were destroyed and capital stock was reduced, while higher temperatures could affect the health of employees and reduce productivity, she said.
“Unemployment could be persistently higher if people are unable or unwilling to leave a region that has suffered from extreme weather and related job losses,” Ms Bullock said.
“Climate impacts vary significantly across regions – an impact may be small in aggregate, but extreme for a local community.”
Ms Bullock also pointed to potentially increased pressure on energy prices as the economy transitions to renewable energy, away from coal-fired power and fossil fuel generated sources.
Australia’s economic reliance on exporting fossil fuels was also another uncertainty Ms Bullock cited, which currently account for “over a third” of the value of Australian exports.
However, she noted that could be offset by opportunities arising from low-emissions industries, and pointed to growing demand for minerals, including cobalt, lead, lithium and zinc, which are used in batteries, solar panels and wind turbines.
