This paper analyses the implications of climate change for the conduct of monetary
policy in the euro area. It first investigates macroeconomic and financial risks
stemming from climate change and from policies aimed at climate mitigation and
adaptation, as well as the regulatory and fiscal effects of reducing carbon emissions.
In this context, it assesses the need to adapt macroeconomic models and the
Eurosystem/ECB staff economic projections underlying the monetary policy
decisions. It further considers the implications of climate change for the conduct of
monetary policy, in particular the implications for the transmission of monetary policy,
the natural rate of interest and the correct identification of shocks. Model simulations
using the ECB’s New Area-Wide Model (NAWM) illustrate how the interactions of
climate change, financial and fiscal fragilities could significantly restrict the ability of
monetary policy to respond to standard business cycle fluctuations. The paper
concludes with an analysis of a set of potential monetary policy measures to address
climate risks, insofar as they are in line with the ECB’s mandate.
