Response of Inflation to the Climate Stress: Evidence from Azerbaijan

Yusifzada, Tural (2022): Response of Inflation to the Climate Stress: Evidence from Azerbaijan. Published in: Central Bank of the Republic of Azerbaijan, Working Paper Series No. 02/2022 (January 2023): pp. 1-28.

Abstract

This research is the first study that analyzes the effects of climate change-related factors on the inflation environment in Azerbaijan during 2005-2020 and forecasts annual inflation for the 2021-2030 period. For this purpose, considering the possible long-run cointegration relation among variables and limited historical observations, the chain impact of temperature on agricultural producer prices is analyzed through the BVAR model. Additionally, the transition requirements to the effects of green energy on inflation are examined through the exchange rate pass-through. Since the aim of the research is to reveal climate change’s impact on the long-run trend of inflation, the study generates two climate scenarios for the 2021-2030 period and analyzes the inflation difference at the end of the horizon. According to the model results, climate change’s contribution to inflation is expected to be 1.3 percentage points (pp) in the long run with the baseline scenario, where climate-related variables follow their historical trends. On the other hand, climate contribution to inflation is estimated to be 2.2 pp in the worst scenario of climate change, where 1.2 °C additional temperature anomaly deteriorates the trends. The results imply that climate change is not only the determinant of seasonality but the trend of inflation. In light of these results, the paper highlights the importance of a well-developed climate action plan set by the government and monetary incentives for transitioning to a green environment set by the Central Bank of the Republic of Azerbaijan. This research is the first study that analyzes the effects of climate change-related factors on the inflation environment in Azerbaijan during 2005-2020 and forecasts annual inflation for the 2021-2030 period. For this purpose, considering the possible long-run cointegration relation among variables and limited historical observations, the chain impact of temperature on agricultural producer prices is analyzed through the BVAR model. Additionally, the transition requirements to the effects of green energy on inflation are examined through the exchange rate pass-through. Since the aim of the research is to reveal climate change’s impact on the long-run trend of inflation, the study generates two climate scenarios for the 2021-2030 period and analyzes the inflation difference at the end of the horizon. According to the model results, climate change’s contribution to inflation is expected to be 1.3 percentage points (pp) in the long run with the baseline scenario, where climate-related variables follow their historical trends. On the other hand, climate contribution to inflation is estimated to be 2.2 pp in the worst scenario of climate change, where 1.2 °C additional temperature anomaly deteriorates the trends. The results imply that climate change is not only the determinant of seasonality but the trend of inflation. In light of these results, the paper highlights the importance of a well-developed climate action plan set by the government and monetary incentives for transitioning to a green environment set by the Central Bank of the Republic of Azerbaijan.

• Item Type: MPRA Paper
• Language: English
• Keywords: inflation, climate, fossil fuel, green energy, BVAR, forecasting
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q5 - Environmental Economics > Q54 - Climate ; Natural Disasters and Their Management ; Global Warming

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