From climate crisis to cost crisis: inflation dynamics in a warming world (WP/26/13)

Leveraging disaggregated price data across five sectors and exploiting international input-output links, we identify the price effects of both temperature and precipitation extremes. The analysis is both global and South Africa-specific. Our results show that weather shocks primarily generate sector-specific, upstream inflation, concentrated in food, energy and transport, with limited and often insignificant pass-through to measured core inflation. Effects are strongly non-linear in the intensity of the shock and are largest for compound heat-and-drought episodes. Importantly, countries operating under inflation-targeting regimes exhibit significantly dampened price responses, reflecting anchored expectations rather than aggressive policy intervention. These findings carry important implications for inflation management. Climate-driven inflation differs fundamentally from demand-driven inflation, and the moderate, transitory shocks in our sample do not warrant systematic policy tightening: raising rates against weather-driven spikes deepens output losses without containing inflation, especially when shocks originate upstream. Central banks should generally ‘look through’ first-round climateflation and coordinate with fiscal and structural policies for adaptation and supply-side adjustment. The exception is salience: because food and energy weigh heavily in inflation perceptions, protracted or repeated shocks that keep headline inflation elevated could unanchor expectations and justify a response.