Climate-Augmented Taylor Rule: Integrating Climate-Induced Supply Shocks into Monetary Policy for Asian Economies

Abstract

This study aims to assess the monetary policy behaviour in nine Asian economies, namely, Pakistan, India, Bangladesh, Sri Lanka, Vietnam, Thailand, Philippines, Indonesia and Malaysia, and determine whether a Climateächlich Taylor Rule (CATR) is more representative of the monetary policy behaviour for the period 2002-2024. The analysis is based on the standard Taylor framework, but with a composite Climate Shock Index (CSI) based on Principal Component Analysis (PCA) of temperature anomalies, rainfall deviations and disaster-related indicators, which are used as proxies for climate-driven supply shocks. Results indicate that climate shocks have a positive and statistically significant impact on policy interest rate, even after controlling for inflation and output conditions, using dynamic panel techniques including diagnostic testing and robustness checks. Country-specific coefficients indicate a stronger climate response for more Agriculture-dependent and climate-vulnerable economies like that of Pakistan, Bangladesh, and Sri Lanka, implying high cross-country heterogeneity. The results overall suggest that conventional Taylor rule types are incomplete when facing rising climate risks and argue for the inclusion of climate variables in monetary policy reaction functions for the emerging Asian economies.

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