The effects of climate change on the natural rate of interest: A critical survey

Abstract

This survey reviews the literature about the possible impacts of climate change on the natural rate of interest (r*), an important yardstick for monetary policy. Prima facie, economic, and financial developments can lower r* in scenarios with increasing climate-related damages and uncertainty that reduce productivity growth and raise precautionary savings. Orderly climate policies have a pivotal role in facilitating the transition to a carbon-neutral economy and supporting a steady investment flow. We discuss the main models used to simulate the effects of climate change on r* and summarize the outcomes. However, in scenarios that assume innovations and investments induced by transition policies, r* could be affected positively. Overall, the downward effects of climate change on r* can be substantial, even considering the high degree of uncertainty about the outcomes, with tipping points and nonlinear effects aggravating the economic impacts. The downward pressure on r* will further challenge monetary policy in the long run, by limiting its policy space.