Matteo Ciccarelli, Head of Forecasting and Policy Modelling Division at the European Central Bank, will deliver a keynote on “Macroeconomic Effects of Climate Related Shocks Over the Business Cycle” on December 15th, 11:00-11:45 CET at the 7th edition of the “Green Finance Research Advances” conference, co-organized by Banque de France and the Institut Louis Bachelier.

On the sidelines of the conference, Matteo Ciccarelli kindly accepted to answer a three-question interview, which we invite you to read below.


Climate change refers to shifts and transformations that happen over long time horizons, extending beyond the traditional horizons of most financial actors. While an understanding of long-term phenomena governing the joint evolution of climate and the economy is key, as well as accounting for financial institutions’ transition plans to the net-zero world of the future, there are also short and medium-term dynamics associated with the transition. What are the key short-term risks associated with climate change and the transition? 

MC: There is increasing evidence that climate change is not only a slow-moving phenomenon with long term consequences. Climate change is also a source of economic shocks that have short to medium term implications for monetary policy. These “climate shocks” are mainly caused by two types of risks: physical and transition risks.

Shocks caused by physical risk for example include events such as forest fires, droughts or extreme precipitations. These phenomena can have a direct impact on the economy, as witnessed during the summer in France, where forest fires of a rare intensity ravaged parts of the country. Periods of intense droughts in agriculture-intensive regions can also be a source of shocks by reducing crops and increasing food prices. In a recent work with Fulvia Marotta, we find that climate shocks stemming from physical risk are akin to aggregate demand shocks. These shocks therefore matter for stabilisation policies because they reduce inflation and lower GDP.

In contrast, climate shocks caused by transition risk can be classified as aggregate supply shocks, especially if they are related to technological mitigation. These shocks tend to reduce GDP while generating inflationary pressures. Shocks stemming from transition risk, for example, arise because of the need to deploy climate policies. The main market failure at the origin of climate change is that carbon emissions have no price. Policies that aim to correct this market failure by imposing a price on emissions are a source of shocks that fall within this category. In Europe, owing to the importance of the Emissions Trading System, which covers around 40% of greenhouse gas emissions, we observe large fluctuations in the price of permits. Some of these fluctuations can be caused by changes in the stringency of environmental policies. This novel source of climate-related shocks is another example of short-term risks stemming from the transition.

Not all climate policies are market-based policies. Most policies (such as the emission limits or the R&D expenditures), while not creating financial incentives to reduce emissions, can in fact be supportive of production and consumption of new green technology, either via fiscal incentives (such as the one created by the US Inflation Reduction Act) or through R&D expenditure. Our research shows that this type of transition risk due to green innovation is akin to negative aggregate supply shocks which increase prices and reduce output.


What is in your views the role of central banks and supervisors in addressing these shorter term climate-related risks? 

MC: Monetary policy and supervision only have a secondary role in directly addressing short-term climate-related risks. Alleviating the risks stemming from climate change, both in the short and long term is mainly a task for governments, which have the necessary tools to price carbon emissions, and hence address the root cause of the problem. International organizations such as the United Nations will also play a critical role, as the implementation of environmental policies will require a major coordination effort.

Within their mandates, central banks can nevertheless take measures that make a difference. At the European Central Bank, we have decided to tilt our corporate bond holdings away from companies with poorer climate records. Our collateral framework has also been adjusted to better account for these risks.

A main duty of central banks is to understand the implications of climate-related shocks for monetary policy. Given the mounting evidence that these shocks affect economic activity in the short term, it is becoming clear that they have a direct impact on central banks’ primary mandates. In the Forecasting and Policy Modelling division, we have started to take these risks into account by incorporating climate change into our models. This modelling effort will allow us to better understand and anticipate how climate-related shocks affect inflation and output.

Climate-related shocks also have major implications for financial stability. In this regard, some important progress has been achieved in the domain of bank supervision. Indeed, as the frequency and intensity of natural disasters is likely to increase, there is an urgent need to assess the resilience of the financial system to this new source of risk. An important first step has been implemented by incorporating climate risk into stress testing. This important measure of financial resilience allows supervisors to assess the ability of financial institutions to withstand extreme shocks caused by physical or transition risk.


What are key academic research questions related to these short and medium-term transition risks? 

MC: As illustrated by Professor Nordhaus’ Nobel Prize-winning research, most of the academic literature has focused on the long-run macroeconomic implications of climate change. The focus on business cycle frequency, which studies short to medium term implications, is more recent and started about a decade ago. For academic researchers, this offers a unique opportunity to contribute, as many key questions have been left unanswered.

Providing a comprehensive list of possible topics is beyond the scope of this interview. Let me instead mention two main directions, which I see as potentially promising, both from an academic and a policy perspective.

First, we still need more empirical evidence of the effects of climate-related shocks on macroeconomic aggregates. My work with Fulvia Marotta is hopefully a useful first step but much more work can be done. Indeed, our paper only scratches the surface of what I hope will become a very active research field in the coming years. Understanding for instance whether inflation pressures stemming from climate-related shocks are more demand or supply type of shocks is of great importance for central banks and the fulfilment of their mandate on price stability (see e.g., the recent focus in the ECB Economic Bulletin, no 7/2022).

Second, as data availability improves, it will also be important to take a more granular approach to better understand the distributional implications of these shocks. The scarce evidence available so far suggests that climate-related risk could have a disproportionate impact on poorer households. Some sectors of the economy will also be hardly hit by the green transition. It will be important to understand how resources will be reallocated across green and brown sectors as well as the possible obstacles to an orderly transition.

The issue of heterogeneity also strikes me as crucial from a theoretical perspective. To ensure a smooth transition to a low-carbon economy, fiscal policy is bound to play a major role. Indeed, as it has been the case for the energy price shock that we are experiencing, shocks linked to the green transition are very likely to exacerbate inequalities. Governments will thus need to resort to fiscal redistribution to alleviate the possible adverse effects of the transition on the most vulnerable. From a modelling perspective, therefore, a major challenge will be to develop frameworks that can be used to study how climate risks and redistributive policies will affect the entire wealth and income distribution. Owing to the progress made in solving heterogeneous agent models in recent years, it should hopefully be possible to develop such modelling frameworks in a near future.

Don’t miss the keynote intervention of Matteo Ciccarelli at Green Finance Research Advances!  The 7th edition of GFRA will take place on December 14-15, 2022 in Paris and online.

The objective of the conference is to bring together academics, finance practitioners and regulators, to discuss together research issues related to the integration of climate risks (more generally environmental issues) into macro-economic modelling/forecasting and into the risk assessment of the financial sector.

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