The rise and fall: Climate change and inflation modelling

By Nick Spencer and Adél Drew

Does your modelling allow for the inflationary effects of the low-carbon transition? And do you understand how tensions may build to create inflation spikes? Do your models implicitly assume that a 2% inflation target will be sustained? 

Historically, the economic cost of polluting the world wasn’t paid for. Transitioning to a non-polluting model – which will involve upfront investment, the conversion of processes, and supply chain transformation – is almost certain to cost more. Any efficiencies gained could reduce costs in the long run… But that is a way away. 

In addition, physical climate factors will almost certainly come at a cost, with more severe weather damaging assets and livelihoods, causing food and water insecurities and increasing global inequalities – and, as a result, geopolitical tension.

It is therefore plausible that we will see higher and probably more volatile inflation in the short term. To explore this hypothesis, we at Milliman developed a UK model to look at how sustainability and inflation relate to one another. Our goals were to understand how inflation could evolve, to learn about the potential for different inflation regimes, and to identify precursors where there are heightened risks of inflationary spikes because of sustainability narratives.

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