Effect of climate change on r*
In this paper Mongelli et al. review the channels through which climate change can affect r*, namely demography, productivity and risk aversion (in the form of higher precautionary savings). They find that climate change mostly has a dampening effect on r*. They then discuss the main models used to simulate the effects of climate change on r* and conclude that the downward effects of climate change on r* can be substantial, even taking into account the high degree of uncertainty.
Lower levels of the natural rate of interest reduce a central bank’s policy space since it increases the likelihood that the ELB becomes binding. This adds to the uncertain impact of climate change on the output gap, which would also imply that guidance from Taylor rules weakens. The reduced policy space for conventional monetary policy might only partly be compensated for by unconventional policy tools like QE. Therefore, it will be important to conduct policies that can help to avoid hitting the ELB, including fiscal policy. Government measures are the most obvious and effective way to foster to transition to a climate-neutral economy. An orderly transition will mitigate the economic and financial risks of climate change and thereby also prevent potential downward effects on r*.
The effects of climate change on the natural rate of interest: a critical survey
Authors: Francesco Paolo Mongelli, Wolfgang Pointner, Jan Willem van den End
From: ECB
Conceptualizing the relation between r* and climate change
In this paper Nicholas Muller takes a different approach by answering the question of whether a central bank can operationalize management of environmental pollution and climate risk through monetary policy. He proposes a green interest rate, r(g), that transmits information on pollution damages to borrowers and lenders. It is actually a reconceptualization of the natural interest rate, r*, that recognizes an expanded role for central banks inclusive of managing environmental risks. Muller develops a New Keynesian model where output is produced with polluting technologies and consumers face the neoclassical consumption-savings problems. The solution that accounts for pollution damage yields r(g), while the solution without the pollution damage yields r*. He argues that in economies on a cleaning-up path, r(g) exceeds r* but for those growing more polluted, r(g) is less than r*.
[T]he goal of this paper is to demonstrate how a central bank could apply r(g) autonomously; that is, without coordinating with an environmental regulator charged with enactment of traditional environmental policy (such as a Pigouvian tax). Political and social obstacles to meaningful climate policy in the near term render this context most broadly relevant.
On the Green Interest Rate
Authors: Nicholas Z. Muller
From: Carnegie Mellon University
