When climate runs hot: monetary policy effectiveness under temperature anomalies

Abstract

This thesis examines how temperature anomalies modify the effectiveness of monetary policy in an emerging economy context. Using a panel dataset of Mexican cities from 2013 to 2024, I estimate the heterogeneous effects of monetary policy shocks under varying climate conditions. The empirical strategy combines local projections with an instrumental variable derived from the trilemma of international finance framework. Results show that episodes of extreme heat systematically attenuate the local responses of inflation to monetary tightening. While the initial attenuation is concentrated in non-core inflation, it progressively extends to core components, suggesting that persistent climate shocks alter both inflation expectations and price-setting behavior. These findings underscore the need for central banks to incorpórate climate risk into macroeconomic modeling, inflation forecasting, and the design of effective monetary policy.