The Expectations Channel of Climate Change: Implications for Monetary Policy

45 Pages Posted: 15 Mar 2021

See all articles by Alexander Dietrich

Alexander Dietrich

University of Tübingen

Gernot J. Müller

University of Tuebingen - Department of Economics

Raphael Schoenle

Brandeis University

Date Written: March 2021

Abstract

Using a representative consumer survey in the U.S., we elicit beliefs about the economic impact of climate change. Respondents perceive a high probability of costly, rare disasters in the near future due to climate change, but not much of an impact on GDP growth. Salience of rare disasters through media coverage increases the disaster probability by up to 7 percentage points. We analyze these findings through the lens of a New Keynesian model with rare disasters. First, we illustrate how expectations of rare disasters impact economic activity. Second, we calibrate the model to capture the key aspects of the survey and quantify the expectation channel of climate change: disaster expectations lower the natural rate of interest by about 65 basis points and, assuming a conventional Taylor rule for monetary policy, inflation and the output gap by 0.3 and 0.2 percentage points, respectively. The effect is considerably stronger if monetary policy is constrained by the effective lower bound.

JEL Classification: E43, E52, E58

Suggested Citation

Dietrich, Alexander and Müller, Gernot J. and Schoenle, Raphael, The Expectations Channel of Climate Change: Implications for Monetary Policy (March 2021). CEPR Discussion Paper No. DP15866, Available at SSRN: https://ssrn.com/abstract=3805281

Alexander Dietrich (Contact Author)

University of Tübingen ( email )

Germany

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Raphael Schoenle

Brandeis University ( email )

Waltham, MA 02454
United States

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