The monetary implications of climate risks in the US: Temperature shocks and price stability

This study aims to examine the effects of climate risks on price stability in the US, which has a global impact on the economic consequences of climate change. To do this, the effects of temperature shocks derived from historical temperature anomalies on realized and expected inflation at different maturities are analyzed using monthly data from January 1980 to December 2024, employing the Bayesian Local Projections (B(LP)) method. The study's findings indicate that temperature shocks cause delayed but significant and persistent inflationary effects on both realized and expected short- and medium-term inflation. Notably, while inflation expectations up to a 5-year term are affected by temperature shocks, no statistically significant effects are observed in longer-term expectations. These findings suggest that temperature shocks weaken the Fed's ability to stabilize short-to medium-term inflation expectations, highlighting the need to consider their structural effects on price stability. It is recommended that the FED develop proactive policies that address climate risks, support green financial product markets, and implement regulations to reduce price volatility in sectors that are relatively sensitive to climate change, in coordination with fiscal policy. Additionally, it is expected that the FED will lead the way in implementing more resilient policies among central banks worldwide by clearly and transparently communicating to the public that climate risks are on its policy agenda. • Investigates the impact of temperature shocks on U.S. inflation and price stability. • Distinguishes between effects on realized inflation and inflation expectations. • Applies Bayesian Local Projections to monthly data from 1980 to 2024. • Measures temperature shocks using historical anomalies and volatility indicators. • It finds that climate risks drive both short-term volatility and long-term inflation bias.