A randomized control experiment conducted by the European Central Bank (ECB), published as Working Paper Series No 3132, found a causal link between rising global temperatures and long-term consumer inflation expectations. The study, based on a large-scale survey of euro area consumers, shows that a hypothetical 0.5∘C rise in global temperatures induces a 0.65 percentage point increase in five-year-ahead inflation expectations. Consumers expect this inflation to be broad-based, affecting food prices, energy prices, and other goods, but attribute the sharpest price increases primarily to supply-side disruptions, such as crop failures, higher production costs, and supply chain issues. Crucially, consumers with greater climate change awareness exhibit a significantly stronger upward revision of their inflation expectations. This suggests that while knowledge about monetary policy typically anchors inflation expectations, greater climate knowledge may make it more difficult for central banks to maintain price stability expectations.
The ECB study offers a crucial framework for Indian policy, as the nation is acutely vulnerable to climate change and relies heavily on agriculture. The key policy takeaway is the risk of de-anchored inflation expectations due to climate shocks. Since food has a large weight in India’s CPI basket, consumer anticipation that climate events (like floods or heatwaves) will cause persistent supply-side disruptions (crop failures) poses a direct threat to the RBI’s inflation-targeting mandate. This necessitates the RBI to integrate climate scenario analysis into its macroeconomic models and develop a robust public communication strategy to manage these climate-induced inflation beliefs.
What is the Expectations Channel of Climate Change? This is a channel through which climate change affects the economy, not just through direct physical damages, but by changing household and firm beliefs about future inflation, growth, and risk. It matters because altered consumer expectations can quickly influence consumption, wage demands, and investment, making climate change a core concern for central banks.
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