For central banks, the effects of climate change and of the transition to a sustainable economy on inflation are particularly important. While the effects of climate change on the real economy have been relatively well studied, the effects on inflation are somewhat less understood.^[16] For example, see the review of the research literature in “Acute physical impacts from climate change and monetary policy”, Network for Greening the Financial System, technical document, August 2024. Price movements that follow climate-related events are examples of relative price changes.^[17] If prices of some individual products rise, this is not inflation in the real sense. The price of a particular product may increase if it is currently in high demand or if the production or distribution of the product is disturbed, leading to a fall in supply. Such price increases are called relative price changes, which is to say that some individual prices rise relative to others. One example is drought and high temperatures in southern Europe in the summer of 2022, which led to a drop in production and a sharp rise in the prices of vegetables. Monetary policy cannot control the prices of individual goods but has the task of influencing general price developments. The relevant question for central banks is therefore to what extent relative price changes lead to persistent changes in the general price level. And this in turn largely depends on how monetary policy is formulated.

Research on how society's transition to a sustainable economy can affect monetary policy is under development and staff at the Riksbank have contributed to this growing research literature.^[18] For an overview, see “The green transition and the macroeconomy: a monetary policy perspective”, Network for Greening the Financial System, technical document, October 2024 An important issue is how the changes in relative prices resulting from either climate events or climate change prevention measures, such as taxes and subsidies, can affect the design of monetary policy. In 2023, researchers at the Riksbank conducted a study of the economic consequences of a rise in the price of fossil-based energy due to the gradual introduction of a carbon tax.^[19] The model is designed to mimic the EU's 'Fit for 55' package, with the price of brown energy gradually increasing by around 50 per cent over a 15-year period. The study also examines how the carbon tax affects the optimal formulation of monetary policy. In the model developed in the study, it becomes more relevant for monetary policy to focus on different inflation metrics that remove the effects of energy prices during the transition to a sustainable economy.^[20] See C. Olovsson and D. Vestin (2023), “Greenflation?” Working Paper Series No 420, Sveriges Riksbank (under publication in the European Economic Review). Another study produced within the framework of the Riksbank's technical assistance analyses how monetary policy should be formulated when a country with a large agricultural sector is affected by extreme weather events. Within the study, one metric of core inflation is defined as CPI inflation adjusted for agricultural prices. The authors show that in the case studied, when the agricultural sector is affected by extreme weather events, monetary policy should stabilise core inflation rather than CPI inflation.^[21] See M. Jonsson, C. Kamanzi, P.A. Kwizera and J.C. Niyonsenga (2024), “Adverse weather shocks and monetary policy in Rwanda”, Staff memo, November, Sveriges Riksbank.

How monetary policy will respond in practice to relative price changes that arise from climate-related actions and events cannot be determined with any certainty in advance. For example, the central bank may not be able to ignore relative price changes and rely on inflation returning to target on its own. In particular, the risk of damaging confidence in the inflation target when inflation deviates significantly from the target needs to be taken into account, as a loss of confidence can lead to and amplify spillover effects in price setting and wage formation.^[22] See, for example, the discussion in E. Thedéen (2023), “Lessons from a turbulent period”, speech, 20 December.

Another fundamental research question concerns the impact on economic growth in both the short and long term. The transition to a sustainable economy involves major investment in infrastructure and industry, among other things, which has an impact on potential output and the neutral interest rate, for example. The neutral interest rate is defined as the policy rate that has neither a stimulating nor a restrictive effect on the economy and is determined in the long term primarily by global saving and investment patterns. The transition to a sustainable economy may affect the level of the neutral rate, but it is uncertain in which direction. For example, an increased investment puts upward pressure on the neutral interest rate. On the other hand, if growth prospects deteriorate, the neutral interest rate will fall. What the final effect will be is thus uncertain and may vary between countries and over time. More research is needed in this area.^[23] See, for example, M. Jonsson and C. Nilsson (2025), “The impact of the green transition on the natural interest rate”, Staff memo, Sveriges Riksbank (forthcoming) and E. Bylund and M. Jonsson (2020), “How does climate change affect the long-run real interest rate?”, Economic Commentaries, No. 11, Sveriges Riksbank.

Another area that researchers at the Riksbank have been involved in investigating is how the yield on government bonds is affected by both acute and chronic climate events. An empirical study using data from a large number of countries finds that interest rates rise as a result of transition risk and chronic climate events. The study also shows that acute climate events tend to negatively affect growth, increase public debt and contribute to greater variability in inflation.^[24] See S. Anyfantaki, M. Blix Grimaldi, C. Maderia, S. Malovaná and G. Papadopoulos (2024), ”Climate Risks and Sovereign Risks Nexus”, International Banking Research Network.