South African Reserve Bank working paper links climate change to higher inflation pressures and a conditional case for green credit alongside carbon taxes

The South African Reserve Bank published Working Paper WP/25/15, Climate change, monetary policy and price stability in South Africa, examining how climate damages and transition policies in a coal-intensive economy can affect inflation dynamics and the transmission of monetary policy. Using a two-period general equilibrium model with heterogeneous agents, climate externalities and endogenous money creation, the paper finds a trade-off between climate change and inflation, with climate damages raising inflation relative to a no-damage benchmark and implying that a higher policy rate may be needed to meet a given inflation objective. Model results also indicate that carbon taxation and “green” monetary policy tools can be complementary. In the paper’s simulations, the inflation response to a higher carbon tax is non-monotonic, with moderate tax increases lowering inflation by reducing future climate damages, but sufficiently high taxes eventually raising inflation as higher energy costs and reduced output dominate, with welfare gains from taxation fading beyond roughly a 90% tax rate in the example. A green credit discount that lowers borrowing costs for green firms can increase welfare when the carbon tax is set below its efficient level, improving social welfare by up to 0.2% when the tax rate is below 0.1, but the benefits diminish as the tax rises and the subsidy can become inflationary, pointing to a need for calibration and an exit strategy linked to measurable shortfalls in the carbon tax path. The working paper is intended to elicit comments and does not necessarily represent South African Reserve Bank policy.