The Impacts of Extreme Weather Events on Inflation and the Implications for Monetary Policy in Africa

Abstract

Economic debates around mitigating climate change and weather-related events have long centred on fiscal policy tools than those of monetary policy. However, recent discussions point out that monetary policy formulation could also be affected and hence the need to deploy monetary policy tools as well. Our article seeks to investigate the impacts of climate change, particularly extreme weather events, on headline inflation and food price inflation and their apparent implications for monetary policy in Africa over the period 1990–2017. Using a two-step dynamic system Generalized Method of Moments estimation strategy with robust standard errors, we find that weather-related events may need to be large and consequential to cause a significant price hike in Africa. We also find the incidence of droughts and floods to have a bearing on food price inflation. Furthermore, our empirical evidence using mediation analysis, reveals agricultural production to be the critical mechanism whereby extreme weather events affect headline inflation. As central banks are charged with the mandate of ensuring a stable monetary environment, we suggest that monetary policy authorities consider the short and long run impacts of supply shocks caused by extreme weather events on general price levels in their policy formulation.