Stockholm (NordSIP) – The first step in understanding how climate change affects price dynamics is to consider its direct effects before engaging with second-order mechanisms. According to the aptly titled “A new age of energy inflation: climateflation, fossilflation and greenflation” speech by Isabel Schnabel, Member of the Executive Board of the ECB, “climateflation” seems to appears to the direct effects of climate change on the price level via its destructive physical impact on infrastructure and the production of goods.
Schnabel uses the example of “natural disasters”, characterised as “severe weather events” such as “droughts”. Under this category, one could also include the increased and more severe incidence of floods and hurricanes. These events have a destructive effect. They destroy physical infrastructure (e.g.: roads, bridges, office, commercial and residential buildings, factories) and or agricultural crops and have the potential effect of killing people.
In purely economic terms, as the quantity of infrastructure and goods for sale decrease their price increases, leading to a rise in price growth, which we call inflation. This is the direct price effect of climate change.
Extreme Weather Events
According to the Global Warming Index, managed by researchers from the Environmental Change Institute at the University of Oxford, the estimated contribution from human-induced global warming, caused by the burning of fossil fuels or other forms of pollution, was equivalent to 1.2163ºC as of December 2022, a significant share of the total.
However, climate change is not only global warming. This increase in average global temperatures disrupts climate patterns and causes more and stronger extreme weather events, such as droughts, storms and hurricanes.
“The Intergovernmental Panel on Climate Change Fifth Assessment Report (2014) showed that changes in many extreme weather and climate events have been observed since about 1950. There is evidence of a human contribution to changes in temperature extremes, heavy rainfall events, and an increase in extreme high sea levels in a number of regions. Attribution science is adding to this evidence all the time. This rapidly developing area of science looks to understand whether human influence on the climate contributed to extreme events by making them more likely or more severe,” explains the UK’s MetOffice.
According to the same source, more than 150 scientific studies looking at weather events around the world confirm the human effect on extreme weather events. “Almost all studies on extreme heat events indicate human influence. (…) About half the studies on drought show significant human influence. (…) A smaller but increasing number of studies on extreme rainfall detect a human signal,” the MetOffice argues.
Interestingly, the situation seems more nuanced regarding tropical storms and hurricanes. “There is strong evidence that increasing sea temperatures increase the intensity of tropical storms. Rising sea levels also increase the risk of coastal flooding. However, there may be an overall decrease in the global total number of tropical cyclones,” the MetOffice adds.
The Economics of Climateflation
Reviewing research by Neumayer, Plümper and Barthel, Irene Lauro, Environmental Economist at Schroders, argues that as extreme weather events increase, so does their cost. This is because the number of extreme weather events has increased, but seemingly so has their strength. “Even after adjusting for changes in wealth (we use GDP as a proxy, since wealth and income are highly correlated with one another), there is still an increasing trend in average natural disaster damage over time,” Lauro explains. 
“The average damage caused by floods in the US was around US$4 billion in the 1990s, up from just $360 million in the 1980s. The average damage in the first decade of 2000 was still substantial, accounting for more than US$1.2 billion. Among the countries we analysed, China seems to be the one most affected by general flooding, with an average loss of $11 billion in the 1990s and $3.6 billion in the first decade of this century,” Lauro adds.
In 2018 report, the OECD cited estimates according to which annual global damages from urban property flooding totalled US$120 billion. According to research published in Nature, the present annual global damage from tropical cyclones is US$26 billion.
From 2011 through 2020, the Centre for Climate and Energy Solutions estimates that the United States experienced nine droughts, each causing at least $1 billion in damages. In November 2022, the World Economic Forum reported that economic damage from droughts jumped by 63% in 2021 compared with the 20-year average, citing research from the World Meteorological Organization.
At the end of last year, the US EPA warned that “Climate change is expected to increase the frequency of heavy precipitation in the United States, which can harm crops by eroding soil and depleting soil nutrients. Heavy rains can also increase agricultural runoff into oceans, lakes, and streams. This runoff can harm water quality.”
The Insurance Perspective
The issue is particularly relevant for insurance companies. A May 2022 report by EIOPIA (The European Insurance ), notes that “at EEA level, the overall gross written premiums [(GWP)] against extreme climate events amount to EUR 19.3 billion accounting for 9% of the non-life business of the sample.”
“In line with the previous observations, the largest premium volume is registered for residential buildings and content insurance coverages (EUR 13.5 billion) of which the large majority is written in Central Europe. (…) In general, insurance coverage against extended weather related hazards costs less than 90 euros a year per property for homeowners, with the most expensive coverages observed in Central European countries and the cheapest in Eastern Europe,” the EEA report adds.
Note: This article is part of a series on the effects of climate change on inflation. Click here to read an introduction to the series and find its accompanying articles.
