IMF Working Papers-Monetary Policy Design with Recurrent Climate Shocks

November 24, 2023--Summary:
As climate change intensifies, the frequency and severity of climate-induced disasters are expected to escalate. We develop a New Keynesian Dynamic Stochastic General Equilibrium model to analyze the impact of these events on monetary policy. Our model conceptualizes these disasters as left-tail productivity shocks with a quantified likelihood, leading to a skewed distribution of outcomes.

This creates a significant trade-off for central banks, balancing increased inflation risks against reduced output.

Our results suggest modifying the Taylor rule to give equal weight to responses to both inflation and output growth, indicating a gradual approach to climate exacerbated economic fluctuations.

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