Climate change could become a major inflation driver in the next decade
Last summer, a blistering heat wave in Europe caused crops to wilt, rivers to dry up, and workers to stay indoors to escape scorching temperatures. The economic blow was expected to cause prices to rise even further, magnifying inflation sparked by the Ukraine war, although experts at the time were reluctant to quantify by how much. The numbers are in now, but even though climate change had a measurable impact on prices last year, it’s nothing compared to how much warmer temperatures, natural disasters, and unpredictable weather patterns will affect inflation a decade from now.
Europe’s high temperatures last summer increased food inflation on the continent by 0.67 percentage points, but the same conditions would be amplified by 50% in 2035 under current projections for weather extremes a decade from now, according to a report published last week by the European Central Bank and the Potsdam Institute for Climate Impact Research.
It gets worse: Without unprecedented investments to adapt to the new reality through innovation to create more resistant agricultural systems, climate change could add one percentage point to global inflation every year between now and 2035. The worst effects would be reserved for food prices, which could rise by over 3% every year as higher temperatures decimate the world’s crops.
“The heat extremes of the 2022 summer in Europe is a prominent example in which combined heat and drought had widespread impacts on agricultural and economic activity,” the report said. “Future climate change will amplify the magnitude of such heat extremes, thereby also amplifying their potential impacts on inflation.”
Inflation’s hidden driver
From the Ukraine war’s disastrous effect on supply chains to corporate price gouging, the list of causes of modern inflation is long, varied, and often open to partisan debate. Climate change should now be added to the list, the ECB report recommends, as higher temperatures are not only making us sicker and poorer, they might soon be the reason groceries are more expensive.
For the report, the ECB analyzed monthly consumer price indices from 121 countries and cross-referenced it with historical climate data over the past 30 years. One of the resulting data sets documented Europe’s inflation and temperature data last year.
During Europe’s sweltering summer, major rivers dried up, affecting shipping companies’ ability to move goods around the continent. Europe’s agricultural industry also came to a standstill, as heat waves caused output of staple crops including maize, sunflower, and soybean yields to plunge as much as 9%.
After accounting for factors such as the Ukraine war and COVID-19’s lingering effect on supply chains, the ECB report estimated that extreme heat on the continent during the three summer months had a cumulative effect of 0.67% on food inflation.
The researchers then combined the data with the latest climate models that project future warming, finding that the inflation persistently exacerbates inflation regardless of a country’s income level, although the effects are stronger in hotter countries and during warmer times of the year.
“[I]nflation goes up when temperatures rise, and it does so most strongly in summer and in hot regions at lower latitudes, for example the global south,” Maximilian Kotz, a scientist at the Potsdam Institute and lead author of the paper, said in a statement.
Climate’s finance and economic risk
Europe wasn’t the only region affected by hot temperatures and high food prices last year. Searing heat waves also hit the U.S. and China last summer, with big consequences for agricultural output. In the U.S., output dropped as Texas cotton, California tomatoes, and Kansas wheat suffered from drought. And in July, Chinese officials warned the country’s farmers were facing “extreme meteorological disasters” after a year of record temperatures and record-high rainfall that created “more and more challenges to agricultural production.”
But while rich nations were given a taste last year of climate change’s devastating effects on food production, developing nations have been living with climate-induced food scarcity for years. In East Africa, for instance, the worst drought in 40 years, which has displaced over a million people, is obliterating agricultural production, with the United Nations warning that extreme food insecurity is paving the way for conflict and instability.
In addition to higher food and material prices, climate change could exacerbate future inflation by dampening worker productivity, which studies show can have a direct effect on higher inflation. Extreme heat already leads to fewer daylight hours worked worldwide, affecting economic output, according to a 2016 UNDP report, while a 2018 University of Chicago study of manufacturing workers in India found that productivity declined 4% for every degree when temperatures exceeded 80° F.
Central banks and financial institutions have started looking closer at climate change as a cause of economic instability and inflation. Last year, the Federal Reserve announced that the six largest U.S. banks would participate in a pilot program designed to assess how different climate scenarios affect financial and economic risk.
