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An orthodox economic take on climate change shocks

Climate change has a significant bearing on macroeconomic outcomes such as growth and inflation.

Guy Debelle, deputy governor of the Reserve Bank of Australia (Photo: Simon Dawson via Getty)
Guy Debelle, deputy governor of the Reserve Bank of Australia (Photo: Simon Dawson via Getty)

In a debate as politically fractious as climate change, it is useful to have credible voices joining the fray. On Tuesday night, the Reserve Bank of Australia (RBA) waded into the waters with a speech by Deputy Governor Guy Debelle. It has immediately been seen as an urgent call to action.

More frequent and severe climate shocks thus mean the cost to the economy is not only greater but also less likely to prove purely transitory.

Some might question what the role of the central bank is to weigh in on such matters. Debelle’s answer is simple and notable – because climate change has a significant bearing on the macroeconomic outcomes, such as growth and inflation, which are the RBA’s core mandate.

An especially useful contribution was to place climate change within a very orthodox macroeconomic framework. We are used to thinking of climate-related shocks as transitory – cyclical occurrences around the trend. What is changing with global warming, however, is that such shocks are becoming more frequent and more severe.

Even temporary shocks can have permanent effects. For example, if workers drop out of the labour force and never return or their skills atrophy. More frequent and severe climate shocks thus mean the cost to the economy is not only greater but also less likely to prove purely transitory. As Debelle puts it:

The supply shock is no longer temporary but close to permanent.

The problem with negative supply shocks is that they raise the spectre of “stagflationary” effects, with inflation rising even as growth slows and unemployment worsens. This directly complicates the central bank’s job, as it is responsible for keeping all three close to their equilibrium levels. Yet, it can only manage the tensions and trade-offs between these policy objectives. It cannot make them disappear. That means households and businesses risk being caught in the worst of all worlds, facing both higher prices and weaker incomes, or one extreme or the other.

Financial fragility is also an issue. Extreme weather-related events pose a major challenge for insurance markets, while companies in carbon-intensive industries are at risk of finding themselves left with large assets on their balance sheets that suddenly become nearly worthless as economies shift in low carbon directions.

One bright spot is that the RBA expects a solid pipeline of investment in renewable energy over the coming years as these are now more cost-effective energy sources.

Aside from that though, it remains a gloomy picture. Human-induced warming has already increased global temperatures by 1 degree above pre-industrial levels and, after so much global dithering, keeping this below 1.5–2.0 degrees will require truly heroic efforts to cut emissions to zero over the coming decades.

Political leadership and international cooperation are obviously the two key ingredients required. Debelle, of course, avoided discussing these topics directly. Nonetheless, there were some interesting points here, too.

On international aspects, he pointed out the ways in which China’s efforts under its latest five-year plan to green its economy is actually benefitting Australia in terms of the increased demand for relatively cleaner coal, natural gas, and battery inputs like lithium. That’s uncontroversial but it makes a useful contrast to all the bluster coming out of the Trump administration that China’s industrial policies writ large are inherently damaging to other economies and must be curtailed. This is especially important to consider given China’s central importance to the trajectory of global emissions. Within reason, we should care more about where they are going rather than how they got there.

On politics, Debelle also made an interesting comparison between climate change and trade liberalisation. Both create winners and losers. But at least with open trade, it is a positive-sum game where it is, theoretically, possible for the winners to compensate the losers and for everyone to still be better off (even if in practice this often doesn’t occur to the extent needed). By contrast, the impact of climate change is a zero-sum affair and so more difficult to manage.

With such distributional issues a key driver, and target, of populist politics around the world, one can only expect that things are likely to get even messier. Hopefully, though, this will be with an eye to more action, rather than less.

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