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An Inflated Burning World

The dual crises of economy and climate

30 يوليو، 2024


If global warming, described by the UN Secretary-General as "global boiling”, has already affected various climate phenomena, and the world's inhabitants have begun to realize the need to adapt to these phenomena and deal seriously with rising temperatures, then the impact on seas, rivers, agricultural crops, and worker productivity must be reflected in the supply of goods, trade movement, capital flows, and labor movements. This inevitability affects economic variables, most notably growth, employment, and price inflation.

Climate Change’s Impact on Production and Productivity 

The laws of thermodynamics govern the movement of energy throughout the universe. When heated, objects expand, and when cooled, they contract. The same applies to the effect of global warming on inflation rates. 

Rising temperatures and extreme weather events are expected to have a global influence on agrarian production. According to a new study published by the Potsdam Institute for Climate Impact Research (PIK), rising average temperatures might cause food inflation and total inflation to surge annually by 3.2% and 1.18% respectively by 2035[i]. 
The scientists examined how climatic conditions such as high temperatures and significant rains have influenced inflation in the past, but they did not investigate which food products were most likely to be affected. It is fairly logical that water-intensive crops and weather-sensitive plants are the most vulnerable to global warming and water shortages.

Climate change's economic ramifications are becoming more widely acknowledged. Empirical methodologies have made tremendous progress in illustrating how historical weather variations affect labor productivity, agricultural production, energy consumption, and human health. The repercussions for macroeconomic production have also been empirically examined, with historical data demonstrating non-linear impacts of average temperature, temperature variability, and various precipitation features on aggregate output. When evaluated through both microeconomic and macroeconomic impact channels, the expected changes in climatic conditions caused by greenhouse gas emissions show large welfare losses.

The Global South is the Most Impacted by Climate Change

Exogenous inflationary pressures from anticipated future temperature conditions are often greater in the global south, with the strongest pressures reported in Africa and South America. This occurs despite higher latitudes being forecasted to see greater warming. Inflationary pressures are already significant in developed nations by 2035, with food inflation in North America and Europe ranging from 1-2% under the baseline definition[ii].

Landslides in Japan and India, wildfires in the US, and storms in Germany are examples of three separate natural catastrophes with a common factor: alarming climate change manifestations. China experienced terrible floods this year, significantly affecting grain and rice supply. China's flood season began earlier than usual, resulting in more violent downpours and floods than in past seasons. The nation has seen a series of pronounced rainfall periods, defined by frequency and intensity. 

China has raised flood alert levels for three provinces: Inner Mongolia, Jillian, and Hilong. These provinces account for 23% of China's rice output. If Beijing does not receive enough rice, it will purchase extra supplies from global markets, pressurizing demand and contributing in further inflationary waves in food supplies. 

Developing countries will suffer the most, as they lack buffers and reserves, while food exporters may be unable to fulfill orders due to their current workloads. 

The Influence of Climate Change on Monetary Policy

Climate change's potential impact on inflation dynamics is becoming increasingly crucial for the conduct of monetary policy and central banks' ability to meet their “price stability” mandate. A comprehensive evaluation of climate risks to inflation is thus a key component in guiding governments' mitigation and adaptation activities, as well as informing monetary policy regarding the risks presented by climate change.

Heinen et al. discovered that climate change-induced floods and storms drove up inflation in 15 Caribbean nations[iii]. Batten et al. found that temperature variations increase the volatility of agricultural and energy costs, which in turn elevates the volatility of inflation[iv]. Klomp and Sseruyange observed that natural disasters dramatically raise a country's price level, regardless of the central bank's independence; from a demand perspective, restoring damaged infrastructure may result in an increase in the prices of related goods[v].

Disaster-Related Channels that Fuel Inflation

Empirical analysis presented in an IMF working paper[vi] demonstrates how climate-induced natural disasters affect inflation and growth through various channels, including (i) altering agricultural production and food prices; (ii) reducing economic activity and labor productivity; (iii) decreasing wealth, income, investment, and consumption; and (iv) impacting transportation infrastructure and distribution costs.

Furthermore, the level of economic growth and diversification in each country significantly influences these transmission channels. These findings reflect demographic and structural inequalities, as well as developing countries' limited budgetary and institutional capabilities to react to and mitigate the effects of climate shocks. Consequently, there are several key implications for economic policy in the face of accelerating climate change:

1. Inflation and growth dynamics will become more erratic, potentially affecting all sectors of the economy. 

2. Varying patterns of inflation and growth response to climatic shocks will result in greater heterogeneity in inflation levels and income growth experienced by different societal groups within a nation. Households whose consumption basket consists of goods and services more susceptible to inflation increases and income loss following natural disasters will be more adversely affected than those less dependent on such products and whose income is not subject to negative shocks. 

Looking ahead, policymakers must evaluate how the green transition away from fossil fuels, a critical component of climate change mitigation efforts, will influence inflation and economic dynamics. Another study conducts a review-type analysis, highlighting three valuable areas of research on this[vii]

1. Rising global temperatures rise will increase demand for refrigeration, air conditioning, and consumer energy use, while simultaneously impacting supplies. This will likely drive up energy prices and contribute to inflation. 

2. As the global climate crisis becomes more apparent, governments may implement stricter regulations and processes, which will increase manufacturers' production costs, affecting price fluctuations and potentially raising inflation. The double difference model could be used to evaluate a country before and after implementing climate policies to determine changes in inflation levels. 

3. Climate change may increase the frequency and severity of natural catastrophes such as floods, droughts, earthquakes, and hurricanes. These events will damage production facilities and significantly reduce crop yields, resulting in diminished supply of agricultural products and other commodities, ultimately causing price increases and inflation. This presents a promising area for further investigation.

The Need for Swift and Effective Climate Action 

Without major action in the next few decades, we are unlikely to keep global warming below 2.7° Fahrenheit (1.5° Celsius) over pre-industrial levels this century—a threshold that experts think reduces the danger of serious negative consequences. However, the more we exceed that threshold, the more severe and pervasive the negative consequences will be, suggesting that it is never "too late" to act.

Transitioning to non-GHG energy sources, such as solar, wind, biofuels, and nuclear, can slow the rate of climate change. However, these energy sources face challenges ranging from manufacturing capacity to debates about installation locations.

Alternative strategies to delay or minimize global warming have been proposed, collectively known as "climate engineering" or "geoengineering." Some geoengineering plans involve cooling the Earth's surface by injecting reflective particles into the upper atmosphere, scattering and reflecting sunlight back into space. Other possibilities include seeding the oceans with iron to induce large-scale phytoplankton blooms, which would remove carbon from the atmosphere via photosynthesis. While such approaches could work in theory, many climate scientists oppose geoengineering until we have a better knowledge of the potential adverse effects. Moreover, there are unsolved legal and ethical concerns surrounding geoengineering.

In response to a request from the United States Congress, the National Academy of Sciences issued America's Climate Choices, a series of peer-reviewed studies providing authoritative evaluations to inform and guide national solutions to climate change. Relevant to this subject, the NAS study Limiting the Magnitude of Future Climate Change outlines actions that can be implemented to reduce or even reverse global warming. The study states: "Meeting internationally discussed targets for limiting atmospheric greenhouse gas concentrations and associated increases in global average temperatures will require a major departure from business as usual in how the world uses and produces energy." Such research must be considered globally, and equivalent work is necessary from the global south.



[i] Climate change risk to price stability: Higher average temperatures increase inflation. (2024). Potsdam Institute for Climate Impact Research. https://rb.gy/ngbct9

[ii] Kotz, M., Kuik, F., Lis, E., & Nickel, C. (2024). Global warming and heat extremes to enhance inflationary pressures. Communications Earth & Environment, 5(1). https://doi.org/10.1038/s43247-023-01173-x

[iii] Heinen, A.; Khadan, J.; Strobl, E. The price impact of extreme weather in developing countries. Econ. J. 2019, 129, 1327–1342.

[iv] Batten, S.; Sowerbutts, R.; Tanaka, M. Climate change: Macroeconomic impact and implications for monetary policy. In Ecological, Societal, and Technological Risks and the Financial Sector; Palgrave Macmillan: Cham, Switzerland, 2020; pp. 13–38.

[v] Klomp, J.; Sseruyange, J. Earthquakes and economic outcomes: Does central bank independence matter? Open Econ. Rev. 2021, 32, 335–359.

[vi] Cevik, S., & Jalles, J. T. (2023). Eye of the Storm: The Impact of Climate Shocks on Inflation and Growth. IMF Working Papers2023(087), A001. Retrieved Jul 27, 2024, from https://doi.org/10.5089/9798400241307.001.A001

[vii] Li, C., Zhang, X., & He, J. (2023b). Impact of climate change on inflation in 26 selected countries. Sustainability15(17), 13108. https://doi.org/10.3390/su151713108