Monetary Policy Stabilization in a New Keynesian Model Under Climate Change

Abstract

We address the question of whether monetary policy is affected by the detrimental impact of climate change on an economy's productivity and, if so, whether policymakers should take it into account when designing policies to stabilize the business cycle. To do this, we develop a new Keynesian dynamic stochastic general equilibrium model of a closed economy which incorporates a climate module that interacts with the economy. In this framework, monetary authorities choose the nominal interest rate on government bonds. The model is solved numerically using parameter values calibrated to the US economy. Our results, which are robust to both extensions and a large number of sensitivity checks, suggest non-trivial implications for the design of optimal monetary policy irrespectively of whether the shocks hitting the economy are standard economic shocks, climate shocks, or shocks to the price of energy.

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