From Heatwaves to Cold Spells: How Extreme Temperature Events Shape Inflation in Germany

In this paper, we develop a novel methodology to identify temperature surprise shocks for hot and cold extreme weather events using granular ground station- and satellite-based weather data for Germany. We focus on food and energy prices, which are key drivers of inflation in Germany and, at the same time, are themselves strongly affected by climate-related shocks. A positive heat shock of one standard deviation increases food prices by up to 0.39% in summer, while the same type of shock in winter decreases energy prices by 0.88%. Moreover, our results indicate that food prices are driven primarily by supply-side factors, as the interaction of a heat shock with a drought variable amplifies the effect through its impact on agricultural production, whereas energy prices respond mainly to demand-side factors, such as changes in heating and cooling needs. Using our identified weather shocks, we estimate the causal effects of extreme temperatures on these two components and trace their pass-through to headline inflation. These results are robust when accounting for nonlinearities arising from seasonality and shock magnitude, the role of transmission channels such as renewable energy production, droughts, and different learning periods in which agents form expectations from past weather shocks.