By Chris Papageorgiou, Giovanni Melina, Alessandro Cantelmo and Nikos Fatouros
This paper analyzes monetary policy regimes in emerging and developing economies where climate-related natural disasters are major macroeconomic shocks. A narrative analysis of IMF reports published around the occurrence of natural disasters documents their impact on important macroeconomic variables and monetary policy responses. While countries with at least some degree of monetary policy independence typically react by tightening the monetary policy stance, in a sizable number of cases monetary policy was accommodated. Given the lack of consensus on best practices in these circumstances, a small-open-economy New-Keynesian model with disaster shocks is leveraged to evaluate welfare under alternative monetary policy rules. Results suggest that responding to inflation while allowing temporary deviations from its target is the welfare maximizing policy. Alternative regimes such as strict inflation targeting, exchange rate pegs, or Taylor rules explicitly responding to economic activity or the exchange rate would be welfare-detrimental. With climate change projected to expand the list of disaster-prone countries, these findings are likely to be soon relevant also for richer or larger economies.
I wonder why this analysis would be limited to emerging and developing economies. Developed economies also suffer major shocks. Covid-19 was in many ways like a natural disaster shock (sudden unavailability of staff, supply disruptions, liquidity needs) leading to major price changes.
The main motivation behind this is that disaster-prone Developing Economies are paying an extremely disproportionate price for Climate Change (compared to their total contribution to the problem which is minimal).
Production in such countries is mainly consisting of tourism services and agricultural output, which is evidencing a low share on the aggregate world emissions. However, those countries are being faced with more frequent and more severe natural disaster occurrences, as a result of Climate Change.
It would be extremely interesting to investigate the impact of major macroeconomic shocks in Developed Economies (several papers are emphasizing on this), but in this paper we take a different approach.
Our narrative analysis focuses on analyzing the experience of those countries, as well as providing insights on how monetary policy can be utilized, in order to alleviate part of the excess burden.
Later, the results of our narrative analysis provide us assistance, in order to construct a model tailored to the characteristics of disaster-prone small open economies.