Executive Summary
Two reports from the Network for Greening the Financial System (NGFS) conclude that physical climate impacts and the transition to net-zero emissions are increasingly material considerations for monetary policy. Floods, heatwaves, droughts, cyclones, carbon pricing, energy-market changes, and green investment can affect inflation and economic output simultaneously, creating difficult choices for central banks. The NGFS finds that an early, orderly, and credible transition entails smaller trade-offs than uncertain or delayed action, while the most severe long-term economic consequences arise without effective climate policies.
The Key Development
Released on June 24, 2026, the first report provides central banks with a framework for evaluating climate-related shocks, monetary-policy transmission, the natural rate of interest, uncertainty, and communications. The second uses the International Monetary Fund’s Global Macroeconomic Model for the Energy Transition to quantify how mitigation policies may affect inflation and output. Physical hazards can damage infrastructure, reduce labor and agricultural productivity, interrupt commodity production, and disrupt supply chains. These effects can lower output while raising food, energy, and other essential prices, producing the characteristics of a negative supply shock. Tightening monetary policy may contain inflation but deepen output losses, while holding rates steady may protect activity but allow persistent price pressure or weaker inflation expectations to develop.
The Evidence and Its Limits
The NGFS modeling compares transition pathways over 10-year horizons, including an economy-wide carbon-price scenario with revenue returned to households and a broader policy mix combining carbon pricing, subsidies, and regulation. The results vary by jurisdiction, fossil-fuel dependence, economic structure, policy ambition, and exchange-rate response. Carbon pricing can increase headline inflation through higher energy costs and production expenses, while adjustment costs can weigh on economic activity. Policy mixes and predictable implementation can moderate some near-term effects. An accompanying analysis estimates that avoided physical damages associated with nationally determined contribution-aligned emissions reductions may, in isolation, raise global GDP by approximately 0.3% in 2035 and produce a positive net effect around mid-century. The report cautions that climate-damage estimates remain uncertain and should not be treated as precise forecasts.
The Implications and Takeaway
The report distinguishes between setting climate policy and responding to its economic consequences. Governments retain responsibility for emissions targets, carbon prices, regulation, subsidies, adaptation, and worker support. Central banks must evaluate how those policies and physical hazards affect inflation, output, credit conditions, asset values, and monetary transmission within their mandates. Pakistan’s 2022 floods and a 2024 cyclone in Mauritius illustrate why responses must reflect local conditions: Mauritius used fiscal support while its central bank focused on medium-term price stability, whereas Pakistan’s inflation increase was followed by substantial monetary tightening. For organizations using Climate Risk Intelligence™, the practical implication is to connect physical and transition risks with commodity prices, supply chains, productivity, insurance, credit availability, investment, and inflation expectations. The central message is not that monetary policy must respond mechanically to every climate-related price increase, but that central banks need better data, scenario analysis, flexible models, and clear communication to distinguish temporary shocks from persistent inflation.
Frequently Asked Questions (FAQs)
- How can climate change affect monetary policy? Climate hazards can reduce productivity and output while raising food, energy, and other prices.
- Why can the energy transition increase inflation? Carbon pricing, regulation, and investment shifts can temporarily increase energy and production costs.
- Are central banks positioned to set climate policy? No. Governments set climate policy, while central banks respond to its economic effects within respective mandates.
- What does it mean to look through a climate shock? It means not changing monetary policy in response to a temporary first-round price increase when broader inflation remains controlled.
- Why does an orderly transition matter? Gradual, credible, and predictable policies allow households, businesses, markets, and policymakers more time to adjust, reducing the risk of severe inflation-output trade-offs.
Sources
- Costa, M. (2026, June 24). Climate change and the energy transition could change monetary policy as we know it. Green Central Banking.
- Network for Greening the Financial System. (2026a, June). Climate change and monetary policy strategy: A guide for central banks.
- Network for Greening the Financial System. (2026b, June). The macroeconomic effects and monetary policy implications of climate mitigation policies: Results from a new quantitative analysis.
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