Climate policy is macro policy: 2022 Volcker lecture at NABE conference

The economic environment is now very different from that which reigned since the global financial crisis. The long era of low inflation, suppressed volatility, and easy financial conditions is ending. It is being replaced by more challenging macro dynamics in which supply shocks are as important as demand shocks, increasing inflation, volatility, interest rates and risk premia. The reaction functions of central banks must adjust accordingly. Climate policy is becoming the third pillar of macro-economic policy. Its conduct will directly impact the efficacy of fiscal and monetary policies, and its interactions with the financial system will heavily influence the pace of job and wealth creation. Estimates suggest that, over the balance of this century, unaddressed climate change could cause the equivalent of a decade of no economic growth, with these losses staying lost. The transition to a net carbon zero economy consistent with limiting temperature rises to 1.5 degrees is forecast to avoid those losses but to put upward pressure on inflation during the initial decade of the transition, until the lower levelized costs of clean energy weigh on prices thereafter. The coordination of monetary, fiscal and climate policies can be expected to improve welfare. A net zero transition guided by credible and predictable policies will accelerate private sector investments, smooth inflationary pressures and improve growth. High and volatile inflation at least can be vanquished. It need not be a permanent condition. The same cannot be said of unaddressed climate change.