Central banks around the world are being urged to revamp their monetary policy frameworks to brace for unprecedented disruptions in employment caused by climate change. A recent study by an economic think tank warns that heatwaves, floods and the transition to a low‑carbon economy could dent labour productivity, trigger large‑scale job dislocations and amplify social inequalities—effects that traditional policy tools are ill‑equipped to manage. As more than a billion workers face exposure to climate risks and economies contend with “sellers’ inflation” from weather‑related shocks, monetary authorities are weighing new strategies to keep growth steady and jobs intact.

Integrating Climate Risks into Monetary Frameworks

Central banks have long focused on inflation, growth and financial stability, but climate‑related labour shocks demand a broadened remit. The London School of Economics report highlights that only a handful of institutions explicitly reference employment in their mandates, even though up to 1.2 billion workers in 182 countries are vulnerable to climate‑driven disruptions such as extreme heat and natural disasters. In richer economies, policy shifts away from carbon‑intensive industries threaten to tighten labour markets, while emerging regions face the brunt of physical risks—ranging from floods that halt factory operations to droughts that decimate agricultural workforces.

To address this, central banks are exploring integration of environmental scenario analysis into rate‑setting and stress‑testing. Under the latest NGFS (Network for Greening the Financial System) “Phase V” scenarios, chronic physical risks—such as persistent temperature rises—could inflict economic damage quadruple earlier projections by mid‑century, outstripping the costs of orderly transition efforts. Embedding these climate scenarios into balance‑sheet assessments and forward guidance allows policymakers to anticipate supply‑side shocks to labour and adjust policy stances proactively.

Some institutions are also broadening their data collection, tracking sectoral productivity under heat stress, monitoring labour supply shifts due to migration from climate‑hit zones, and commissioning research on “seller’s inflation”—where businesses pass on weather‑induced cost increases as higher prices. By mapping out likely labour disruptions, central banks can calibrate interest‑rate paths to cushion employment impacts and signal banks to shore up credit lines for affected sectors.

Heat Stress and Sectoral Productivity Decline

Rising temperatures present an immediate threat to worker output, particularly in toil‑intensive sectors. Studies show that for every degree Celsius above optimal conditions, productivity in outdoor jobs—like agriculture and construction—can fall by up to 2 percent. In Europe, recent heatwaves contributed to €125 billion in lost earnings as wildfire smoke, extreme heat and power outages sidelined workers and disrupted supply chains. Similarly, crop failures in West Africa drove chocolate prices up by 18 percent in the U.K., illustrating how weather‑related shortages ripple through global value chains.

Indoor occupations are not immune: poorly cooled warehouses, factories and kitchens expose workers to heat‑induced fatigue, raising safety risks and absenteeism. In South Asia, projections suggest that by 2050, extreme heat could erase billions in GDP each year, eroding tax bases that fund social programmes and dampening demand for non‑essential services. Floods and hurricanes further displace labour forces, forcing temporary shutdowns of manufacturing hubs and ports.

Transition‑related labour shocks compound these physical risks. As governments tighten emissions standards and phase out fossil‑fuel industries, workers in coal mining, steelmaking and petrochemicals face job losses without clear retraining pathways. Although renewable energy sectors are expanding, mismatches in skills and geography can leave communities struggling to fill new roles. Central banks warn that without coordinated fiscal and training efforts, these shifts could exacerbate unemployment and fuel social discontent—factors that monetary policy alone cannot resolve.

Policy Innovations and Central Bank Interventions

Faced with these challenges, monetary authorities are exploring novel tools beyond traditional rate adjustments. Some are considering “green quantitative easing,” purchasing bonds that finance climate‑resilient infrastructure and low‑carbon technologies, thereby supporting sectors that generate new employment opportunities. Others advocate deployment of buffer stocks—strategic reserves of critical commodities—to stabilize prices when climate events trigger supply shortages.

Regulating profiteering in the wake of climate shocks is another avenue. By tightening oversight of price‑setting in energy, food and transport, central banks can curb unwarranted surges that exacerbate inflation, allowing interest rates to remain supportive of growth and employment. Collaborative frameworks with competition authorities and fiscal policymakers are being drafted to address “seller’s inflation,” ensuring that cost‑pass‑through remains linked to genuine supply constraints.

On the supervisory front, banks are being tasked to stress‑test loan portfolios for climate‑labour risks, assessing how defaults might rise in regions prone to extreme weather or in industries undergoing decarbonization. This regulatory nudge encourages lenders to maintain credit lines for vulnerable firms and to adapt underwriting standards that factor in climate resilience measures—such as investments in cooling systems or flood defences—that safeguard jobs and assets.

Moreover, several central banks are advocating active support for labour‑market transitions. Where mandates allow, they propose incentivizing credit to firms that hire and train workers displaced by the green shift, smoothing the movement of employment towards sustainable industries. Pilot programmes are being discussed to channel concessional financing into vocational retraining centres and green innovation clusters, potentially backed by central bank balance sheets.

Coordination with fiscal authorities is critical. Central banks have called for targeted fiscal stimulus—such as wage subsidies, public‑works programmes focused on climate adaptation, and tax incentives for green job creation—to complement monetary measures. By aligning policy levers, governments can avoid overstimulating already tight labour markets while ensuring that displaced workers find new opportunities in resilient sectors.

Reforming Mandates for a Changing World

The LSE study underscores that reforming central bank mandates is the linchpin for lasting adaptation. Of 114 mandates reviewed, only a handful—including those of the Bank of England, the U.S. Federal Reserve and the Reserve Bank of Australia—explicitly incorporate employment objectives alongside price stability. Expanding mandates to recognize climate‑labour risks would legitimize more proactive interventions and broaden accountability.

Some central banks are already moving in this direction. The European Central Bank has committed to embedding climate considerations into its Sustainable Finance Strategy, linking collateral frameworks and asset purchases to environmental criteria. The Bank of England has signalled intent to deepen its climate stress tests for banks, including labour‑market scenarios. Meanwhile, the Federal Reserve’s recent withdrawal from a climate‑focused network has drawn criticism, prompting calls for renewed engagement with international efforts to develop common risk assessment tools.

Institutional capacity‑building is also crucial. Central banks are hiring climate and labour economists, investing in high‑resolution data infrastructure and forging partnerships with universities and think tanks. Workshops and joint exercises with fiscal ministries, labour agencies and financial regulators aim to foster shared understanding of climate‑labour dynamics and co‑design policy responses.

As climate risks intensify, central banks face a pivotal moment: adapt or risk being left powerless to mitigate shocks that reverberate through jobs, incomes and prices. By integrating environmental employment risks, innovating new policy instruments and reforming mandates, monetary authorities can help steer economies through the unfolding climate upheaval—safeguarding stability in both markets and workplaces.

(Adapted from LSE.ac.uk)

Categories: Economy & Finance, Regulations & Legal, Strategy