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Economy

Fed describes how climate change affects U.S. economy

Climate change has a direct and indirect impact on the U.S. economy and presents "relevant considerations for the Federal Reserve in fulfilling its mandate for macroeconomic and financial stability," according to an economic letter posted on the Federal Reserve Bank of San Francisco's website Monday.

"In coming decades, climate change — and efforts to limit that change and adapt to it — will have increasingly important effects on the U.S. economy," wrote Glenn D. Rudebusch, senior policy adviser and executive vice president in the San Francisco Fed's economic research department.

Hotter temperatures, rising sea levels and more frequent and extreme storms, floods and droughts directly impact the economy, while attempts to "adapt to these new conditions and from efforts to limit or mitigate climate change through a transition to a low-carbon economy" impact it indirectly, Mr. Rudebusch wrote.

"Climate-related financial risks could affect the economy through elevated credit spreads, greater precautionary saving, and, in the extreme, a financial crisis," Mr. Rudebusch added. "There could also be direct effects in the form of larger and more frequent macroeconomic shocks associated with the infrastructure damage, agricultural losses, and commodity price spikes caused by the droughts, floods and hurricanes amplified by climate change."

While the most significant climate-related damage could be years away, climate change's disruptive effects could become more persistent and harder to ignore. Most of the consequences of climate change will occur well past the usual policy forecast horizon of a few years ahead, but longer-term factors can be relevant for monetary policy, he wrote.

"Central banks routinely consider the policy implications of demographic trends, such as declining labor force participation, which have long-run effects much like climate change," he said. "In addition, prices of equities and long-term financial assets depend on expected future conditions, so even climate risks decades ahead can have near-term financial consequences."

On the notion of implementing a carbon tax — charging for the full cost of carbon pollution through an extra fee on emissions — Mr. Rudebusch said it has some support among economists but calculating what that tax should be is difficult.

"For the Fed, the volatility induced by climate change and the efforts to adapt to new conditions and to limit or mitigate climate change are … increasingly relevant considerations," he concluded.