Philip R. Lane, ECB Executive Board member, discusses how climate change and the green transition impact the euro area’s economy and monetary policy, including risks, modelling, and policy responses.
Philip R. Lane, a member of the Executive Board of the European Central Bank (ECB), delivered a keynote speech at the Climate, Nature and Monetary Policy Conference jointly organized by the ECB, the Centre for Economic Transition Expertise, and the Frankfurt School of Finance and Management.
The speech highlighted that global warming is no longer a distant threat, with 2023, 2024, and 2025 being the hottest years on record. Extreme weather events such as heatwaves, droughts, heavy rainfall, and wildfires have increased in frequency and severity, accelerating global warming since the 1880s. Current policies project a temperature rise of around 2.8°C by 2100 under existing measures, or 2.3-2.5°C if all Paris Agreement commitments are fulfilled.
Climate change causes substantial economic damage, reducing global GDP per capita by over 20% since 1960-2019, mainly through long-term effects on productivity, land degradation, and migration. The EU has committed to reducing greenhouse gas emissions by at least 55% by 2030 under the Fit for 55 package, aiming for climate neutrality by 2050. These policies enhance economic resilience and reduce dependence on imported fossil fuels.
Both climate change and transition policies influence output, inflation, asset prices, financial stability, and the transmission of monetary policy. The ECB’s 2021 Monetary Policy Strategy Review committed to integrating climate considerations into its analysis and decision-making processes. The ECB monitors climate impacts on the economy and incorporates these factors into models and forecasts.
The impact of climate change on the euro area includes disruptions to production, energy demand shifts, infrastructure damage, and reduced labor supply, which can lower potential output. Extreme weather events affect different sectors variably, with some sectors like pharmaceuticals suffering under heat, while energy demand responds to cold and heat extremes. Firms in southern Europe report higher risks from extreme events, and insurance gaps exacerbate economic impacts.
Extreme weather also influences inflation, notably food prices, with heatwaves increasing food inflation temporarily and projected future temperature rises potentially amplifying this effect. The overall impact on headline inflation is complex, with some components experiencing inflationary pressures and others deflationary effects, depending on the season and shock type.
The green transition presents opportunities and challenges, including short-term growth and inflation impacts, but long-term benefits such as energy security, reduced volatility, and lower emissions. Scenario analyses suggest transition policies may temporarily raise inflation and dampen growth, but technological advances and increased renewable energy deployment can mitigate these effects over time.
Recent energy crises demonstrated the potential of renewable and nuclear electricity to shield consumers from fossil fuel shocks. The green transition could reduce inflation volatility by decreasing reliance on fossil fuels, with a possible triple benefit: emissions reduction, inflation stability, and energy security.
Investment in green technologies requires substantial capital, with estimates of 2.7-3.7% of EU GDP annually until 2030. ECB surveys indicate increased corporate investment in energy transition, with firms prioritizing climate-related projects. The interaction between the green and digital transitions, especially AI, could influence energy demand and technological development.
Modelling efforts at the ECB include macroeconomic models like the NAWM-E and DREAM, which incorporate energy sectors and emissions. Scenario analyses and model comparisons suggest that higher carbon prices could modestly reduce output and increase inflation, with effects sensitive to assumptions about policy and market responses. The ECB emphasizes the importance of ongoing assessment and adaptation of models to capture climate impacts.
Climate change and transition policies affect monetary policy transmission through asset prices, bank lending, and financial conditions. Climate risks influence the cost of capital, credit standards, and interest rates, with banks incorporating climate considerations into risk management and supervision. The structure of the financial system may evolve, with increased role for market-based financing such as green bonds and equity markets, potentially altering transmission channels.
Climate shocks increase the frequency and severity of supply-side disruptions, complicating policy responses. Central banks may need to balance supporting economic activity and controlling inflation amid rising uncertainty. The impact on the neutral interest rate is uncertain, with opposing forces such as productivity declines and investment needs influencing its direction.
The ECB has revised its monetary policy instruments to incorporate climate risks, including tilting asset purchases toward greener issuers and introducing new collateral frameworks to manage transition risks. These measures support risk management and align with the ECB’s mandate to support economic policies and environmental sustainability.
In conclusion, climate change reduces potential output, increases volatility, and influences inflation and investment. The green transition offers resilience and stability benefits but requires substantial investment and policy adaptation. The ECB continues to develop analytical tools and models to better understand and respond to climate-related risks, emphasizing a data-driven, flexible approach to monetary policy in an uncertain environment.
