The dynamics of climate-related inflation

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The dynamics of climate-related inflation

Sunday, 02 October 2022 | Auvi Mukherjee

The Russian invasion has pushed the world into inflation levels unseen since 1981. Three distinct but interrelated phenomena are driving this climate-related inflation, much of which I will quote from a European Central Bank report, released this March. These phenomena have been described as climateflation, fossilflation and greenflation. Let's examine what they are exactly.

 

 

 

What is Climateflation

 

Climateflation refers to the impact of extreme weather events on supply chain disruptions of ecosystem services-dependent sectors such as agriculture, forestry, energy, and tourism. It results in economic losses in climate-exposed sectors and upward pressure on prices of soft commodities, says the ECB paper.

 

“For example, exceptional droughts globally have contributed to a recent sharp rise in food prices”. In fact, the rise in world food prices hit an all-time high this year, led by surges in vegetable oils and dairy products, according to the UN’s Food and Agriculture Organization. The increase in food prices was mainly driven by a robust demand post recovery from Covid, as well as higher fertilizer and fuel prices which increased production and transportation costs. After the Russian invasion, wheat too rose to record prices, after forecasted decreases in yield due to high temperatures. In these examples, climate-related events like changes in precipitation, and heatwaves can result in price volatility and drive inflation.

 

What is Fossilflation

 

“Invariably, it’s the high cost of oil and fossil fuels in general that drive big fluctuations and overall inflation,” - Mark Zandi, Moody’s Analytics. The second structure driving inflation is fossilflation - which is upward pressure on the prices of fossil fuels due to a disorderly transition towards greener energies.

 

A strong cause identified is a powerful demand, unmatched by a constrained supply resulting from fossil fuels, they accounted for 85% of the total energy consumption in Europe in 2019.

 

In addition, climateflation can also impact energy demand. For instance, heatwaves in March in India or abnormally cold winters, raise energy demand. Also, during the transition to greener energies, fossil fuels can be disincentivized before renewables absorb their true potential leading to volatile energy prices.

 

According to the French corporate and investment bank Natixis, to meet climate goals (net zero emissions by 2050), investment levels in oil and gas should be sustained, not increased. The International Energy Agency estimated that current countries' policies fell short to limit global warming to 1.5 Degree C. Between 2020-2030, investments in oil and gas are projected to reach a yearly range of $700 billion, while they should not cross $380 billion, to respect climate goals. Governments must find a practical approach to navigate troubled waters, between maintaining stable economies and respecting the Paris Agreement.

 

What is Greenflation

 

Greenflation has more subtle implications. It refers to the inflation caused by increased capital investment in the transition towards green energy and low-carbon technologies. Most green technologies extensively require some metals like cobalt, lithium, and copper.

 

Decarbonization is expensive. For example,the International Energy Agency reports that ‘electric vehicles use over six times more minerals than their conventional counterparts’. An offshore wind plant requires over seven times the amount of copper compared with a gas-fired plant. In the foreseeable future, green technologies will use a chunk of important metals and minerals. Yet as demand rises, supply is constrained in the short and medium terms.

 

It typically takes 5-10 years to develop new mines and “over 50% of today’s lithium and copper production is concentrated in areas with high water stress levels,” says IEA. The imbalance between, rising demand and constrained supply, is why the prices of many critical commodities have risen immeasurably in recent months. ‘The price of lithium, for example, has risen by more than 1000% since January 2020’, says the ECB paper.

 

And therefore, we are presented with an important paradox, in the fight against climate change. The faster and more urgently we shift to a greener economy, the more expensive it may become in the short run. Interestingly, economist and former Governor of the Bank of England Mark Carney indicates that the transition to carbon-neutral economies will put upward pressure on inflation in the coming 10 years.

 

It is still too early, to hold greenflation accountable for the ‘painful rise in energy prices but as we transition towards a greener future, greenflation can be expected to raise the prices of many critical commodities. But if countries committed to carbon neutrality keep their word, investments made in energy and infrastructure will increase, to about 4.5% of world GDP in 2030, providing an impetus to growth, employment, and pushing equilibrium interest rates, Carney has been stated as saying. Therefore, some may argue that the key to addressing greenflation is indeed more greenflation-more investments that would potentially lead to green deflation as new technologies grow.

 

Role of central bankers and measures required

 

It’s therefore not environment and climate scientists alone who need to wage a war on climate change. Central Banks also have their role cut out. The European Central Bank has drafted two proposals, to approach climate-related inflation, both with their shortcomings. The first one is to raise the inflation target while the second measure is excluding energy prices from the central banks’ measures of inflation.

 

In future, despite whichever path we choose to follow, one thing’s certain. We need to urgently reduce our dependence on fossil fuels, to protect both-our climate and sovereignty. The transition will herald a new era of inflation, one we must prepare for together.

 

In this battle, our role lies in small behavioral changes like carpooling, teleworking, and conserving power. Big ones like investments in recycling facilities, collectively improving food security, and climate activism will go a long way too, as the mercury keeps rising.

 

The writer, a Gold Award winner in the Queen's Commonwealth Essay Competition 2021, is a football enthusiast, an occasional blogger and closely tracks issues around climate change.

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