Impact of Climate Change on South Africa: Evidence from a DSGE Model

We analyze the impacts of climate change and carbon taxation on South Africa using a calibrated small open economy New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model featuring sticky-and-flexible-price specifications. A permanent productivity shock reducing GDP by 5 percent by 2050 lowers the natural interest rate by 7.5 basis points, appreciates the real exchange rate by 4 percent, and generates 4 basis points of inflation, requiring 0.5 basis point policy rate increases above the natural rate. A tenfold carbon tax increase (R236 to R2,360/ton CO2) produces modest long-run output losses (0.22 percent) with 0.2 percent immediate inflation, necessitating 6 basis point policy tightening. Compressed adjustment horizons (2033 versus 2050) amplify short-run effects fivefold, with the natural interest rate declining by 40 basis points under accelerated climate impacts. Results suggest the South African Reserve Bank (SARB) must incorporate climate-adjusted potential output and natural rate estimates into its monetary policy framework, with particular attention to the timing of climate-induced productivity decline materialization which fundamentally determines the magnitude of required policy responses.