The Effects of Temperature Shocks on Energy Prices and Inflation in the Euro Area

Abstract

Over the last twenty years, temperature variability has been increasing across Europe, affecting the economy through the demand for energy for heating and cooling needs. This paper provides empirical evidence about the transmission channel of temperature shocks to inflation by estimating a Structural Vector Autoregressive model (SVAR) for six Euro-Area countries. We study hot and cold shocks by starting from monthly regional temperature anomalies and proposing a novel sign-restriction identification scheme. Hot shocks are more relevant than cold ones because they persistently lower energy prices. The negative impact on energy demand due to heatwaves suggests that a turn-off-heating effect outweighs the turn-on-cooling in Europe. That effect prevails in Northern countries, where energy inflation without heatwaves would be higher than the actual one. At the Euro Area level, the overall effect is sizable although limited: the historical contribution of the highest heatwaves accounted for missing annual headline and energy inflation.

Keywords: Climate change, Macroeconomics, Time series, Energy market, Euro Area

JEL Classification: E3, E31, C3, Q4, Q43, Q54