Climate change requires inflation rethink, says RBA deputy governor

“Climate-related trends could cause central banks to re-examine the relative merits of flexible inflation targeting,”  the deputy governor of the Reserve Bank of Australia has said.

In a speech earlier this week, Michele Bullock explained that heightened uncertainty around how the climate will change and its effects on the financial system poses questions about how the central bank sets its monetary policy in the long term.

“Climate change has macroeconomic implications that are relevant for the setting of monetary policy and the Reserve Bank’s financial stability remit. There are some familiar elements — monetary policy has always had to grapple with supply shocks, structural changes and uncertainty. But some are new – in particular, the heightened uncertainty around how the climate will change and how this will impact the economy and financial system,” she said.

She explained that certain aspects of monetary policy remain familiar, such as handling supply shocks, structural shifts and uncertainty such as food and energy price increases. However, the increased uncertainty surrounding climate dynamics are much more novel and potentially threatening.

Bullock noted that “more intense weather events and higher average temperatures are likely to reduce the value of some assets and income streams”, resulting in “unexpected credit losses for banks, increased claims on insurers and write-downs to the value of financial investments”.

The unpredictable economic and financial repercussions posed by climate change has necessitated the bank to “conduct analysis and research into how climate change will affect the structure and operation of the economy”.

Actions taken to reduce emissions, Bullock said, “may present adjustment costs, but they will also present opportunities”.

Changing interest rates in order to combat inflation has been widely criticised and reports show that combatting fossilflation can be better addressed through “qualitative and quantitative credit regulation”, rather than the “blunt” tool of interest rate changes.

Referring to the physical and transition risks arising from climate change, Bullock said: “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 potential impact of a net-zero transition looms large, with fossil fuels constituting over a third of Australia’s export value. Bullock underscored that the green transition is not driven by monetary policy, a stance contested by many due to the capital-intensive nature of green investments and their susceptibility to interest rate hikes.

Some commentators have concluded that Bullock’s speech signals that one of her priorities will be developing frameworks for considering climate risks relevant to the economy. In May, RBA treasurer Jim Chalmers announced plans to launch the bank’s first sovereign green bonds, while the government recently proposed mandatory climate reporting for companies and financial institutions.