Climate change may force Australia’s central bank to adapt how it uses interest rates to keep inflation under control, the incoming governor warns.

Michele Bullock, who is due to replace Philip Lowe as head of the Reserve Bank of Australia in September, said climate change would affect the economy through several channels.

“Hotter temperatures and more extreme weather will disrupt businesses, damage property and lower productivity growth,” she said at the Sir Leslie Melville Lecture at the Australian National University on Tuesday.

“Actions taken to reduce emissions may present adjustment costs, but they will also present opportunities.”

Her comments followed the release of the Intergenerational Report last week that predicted higher temperatures could reduce economic output over the next four decades by up to $423 billion.

“Navigating uncertainty is an inherent part of the work of a central bank,” she said.

“But the uncertainty around climate change is particularly acute.”

For the RBA’s already challenging task of keeping prices stable, she said climate change could affect the neutral interest rate, which is when monetary policy is considered neither expansionary nor contractionary.

The impact of climate change on the neutral interest rate was not clear-cut.

“In a world where significant climate risks materialise, households may be more likely to accumulate savings and firms may be less willing to invest, putting downward pressure on the neutral rate, and limiting the effective monetary policy space available to policymakers where interest rates are still positive,” she explained.

“On the other hand, the extra investment required to replace capital stocks destroyed by more frequent natural disasters or to transition to a lower emissions economy could put upward pressure on the neutral rate.”

Ms Bullock also said climate-related trends could cause the central bank to re-examine the merits of flexible inflation targeting.

The recent review into the RBA found the flexible target was working well and recommended it stay in use.

“Nevertheless, I expect that debate will continue,” Ms Bullock said.

In the fight against worsening climate change, she said the task of keeping prices low and stable would be all-important.

“Because that then allows businesses and governments to make decisions associated with transition.”

Treasurer Jim Chalmers said the speech was an important contribution from the incoming governor on the impact of climate change on the economy and financial market stability.

“The Albanese government’s economic plan is designed to make Australian businesses and Australian workers the beneficiaries not victims of the shift to cleaner, cheaper and more renewable energy,” he said.

The central bank board meets next week for its September interest rate decision.

The RBA has been lifting interest rates since May of last year to tackle high inflation, but paused at its last two monthly meetings and in April.

The aggressive tightening cycle is expected to cool the economy and nudge unemployment higher, a risk factor that prompted protesters to briefly interrupt Ms Bullock’s speech.

The incoming governor was reluctant to comment on how long interest rates would stay at their current levels.

“All I can say is we might have to raise interest rates again, but we’re watching the data very carefully.”

Poppy Johnston
(Australian Associated Press)