DP15866 The Expectations Channel of Climate Change: Implications for Monetary Policy

Author(s): Alexander Dietrich, Gernot Müller, Raphael Schoenle
Publication Date: March 2021
Keyword(s): climate change, Disasters, Households Expectations, Media focus, monetary policy, Natural rate of interest, Paradox of Communication, survey
JEL(s): E43, E52, E58
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15866

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.