Central banks’ Integration of Climate Change Issues into an Increased Taylor Rule in the Mediterranean Region: An Analysis based on the System The Generalized Method of Moments (GMM)

Abstract

Climate change could have significant consequences such as rising sea levels, intensified storms, floods, droughts and forest fires. These effects could lead to forced migration, ecosystem degradation and extinction of many species. In addition, they could also affect the ability of central banks to maintain price stability. This research proposes an innovative method to integrate CO2 emissions into a Taylor rule, considering a risk premium related to climate change. This risk premium is determined by the CO2 emission gap. The model is evaluated over a period from 2002 to 2022 for 14 countries in the Mediterranean region, using the two step system Generalized Method of Moments (GMM). The results show that the coefficient associated with the CO2 emission gap is both positive and statistically significant at a level of 5%. This means that a 1% increase in this gap leads the Central Bank to increase its policy rate by 2.64%.