James Talbot, Bank of England, on Climate Shocks and Monetary Policy

How are central banks integrating climate risk? Listen to Jason Mitchell discuss with James Talbot, Bank of England, about why climate risk is no longer a long-run abstraction but is already feeding into inflation, asset prices, and insurance coverage today; how the Bank of England is responding across its monetary policy, prudential regulation, and financial stability functions; and what it'll take to ensure the financial system remains stable and price stability is maintained as the climate transition accelerates.

Recording date: 08 July 2026

James Talbot

James Talbot is Executive Director of the International Directorate at the Bank of England, having been appointed to the role in 2023 after six years as International Director. He is responsible for the Bank's international analysis and risk assessment and sets the Bank's international strategy, including policy development in the G20, G7, BIS, FSB and IMF. He also serves as the Bank's Executive Sponsor for Climate and chairs the NGFS workstream on Monetary Policy. His earlier roles at the Bank include heading Monetary Assessment and Strategy and advising on macroprudential policy, and from 2008 to 2010 he represented the UK on the Executive Board of the IMF.

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Jason Mitchell:

I'm Jason Mitchell, CIO for Responsible Investment at Man Group. You're listening to A Sustainable Future, a podcast about what we're doing today to build a more sustainable world tomorrow.

Hi, everyone. Welcome back to the podcast and I hope everyone is staying well. So if you've listened to enough of these episodes, you know that many of these conversations revolve around a single idea. It could be a book, an academic paper, speech, or a new report, but it is invariably about something that changes, or at least informs, how we think about sustainable investing.

This episode is definitely one of those. Let me explain. I recently came across a recent speech titled Measure, Model, Tackle, Tailor: The Bank of England's Approach to Assessing and Managing Climate Impacts Across Its Core Objectives. Now, I've long been interested in how central banks are approaching climate change, but this speech really resonated with me. In other words, this was one of the clearest and most substantive articulations I've seen of what it actually means to embed climate risk into the core operating framework of a central bank as opposed to, let's say, treating it as a separate parallel agenda.

At the same time, we should recognise that central banks face a real dilemma. Climate risk is becoming increasingly material to their core mandates, think price stability, financial stability, and prudential supervision, yet the policies that determine the climate outcomes largely sit outside their remit. So while central banks can't ignore climate risk, they also can't necessarily be seen as making climate policy. That's the balance they have to strike. Call it the swim lane paradox, which we talk about.

Now, that tension between doing too little and overreaching is why it's great to have James Talbot from the Bank of England on the podcast. We talk about why climate risk has shifted from a long run abstraction into something that feeds directly into inflation, asset prices, and insurance coverage, how the Bank of England is responding across its monetary policy, prudential regulation, and financial stability functions, and what it will take to keep the financial system stable and prices stable as climate shocks become more frequent and the transition accelerates.

James is executive director of the International Directorate at the Bank of England. He's responsible for the bank's international analysis and risk assessment. And sets the bank's international strategy, including policy development in the G20, G7, BIS, FSB, and IMF. He also serves as the bank's executive sponsor for climate and chairs the Network for Greening the Financial System, or NGFS, work stream on monetary policy. His earlier roles at the bank include heading monetary assessment and strategy and advising on macroprudential policy, and representing the UK on the executive board of the IMF.

Welcome to the podcast, James Talbot. It's great to be here recording this at the Bank of England, and thank you for taking the time today.

James Talbot:

Yeah, thanks very much. It's great to be here.

Jason Mitchell:

Excellent, excellent. I'm really looking forward to this conversation. So James, I want to start out by framing some of the key messages from a speech you gave at the LSE, which I found particularly striking. The speech is titled Measure, Model, Tackle, Tailor: The Bank of England's Approach to Assessing and Managing Climate Impacts.

And in that speech, you give this wonderful historical anecdote about the Bank of England installing a wind dial in its boardroom way back in 1805, connected to a weather vane on the roof because an easterly wind signalled an increase in trade as merchant ships sailed up the Thames River. Now, two centuries later, you argue that climate risk is now embedded in the day-to-day mechanics of monetary policy, supervision, and financial stability.

The BOE pioneered a lot of this work under Mark Carney, but since then, the political environment around climate has become a lot more contested, I'd say. In other words, the remit letter changed and the public debate has certainly shifted. Against that backdrop, how do you see the measure, model, tackle, tailor framework advancing the bank's climate capability instead of just holding the line?

James Talbot:

Yeah. So I think that anecdote really shows the centrality of weather to economic activity, and that's not a new thing. And I think that's important actually because it provides the essence of the argument of why climate change matters for central banks. So in the example from the 19th century, a change in the wind meant more economic activity coming into the UK, as you said. But in the 21st century, I think the science tells us that climate change will increasingly affect our weather, and in turn, economic activity and inflation. And so in turn, central bankers spend a lot of time analysing issues that affect economic activity.

And here I think I'd pick out the sort of three core things that the Bank of England does that I'll keep coming back to actually during this podcast. So the first thing we need to do is price stability. The second is the stability of the financial system as a whole. And the third is the safety and soundness of the financial firms that we supervise. And as you said, in the speech, I argue that climate change can affect each of those objectives.

And when we first started working on climate at the bank just over a decade ago, these were all novel issues. But today I think considering the impact of climate change is much more the normal business of central banking. And I think in part that reflects the fact that climate impacts are increasingly visible. Physical risks are intensifying, particularly in some parts of the world, and transition policies are also beginning to affect relative prices, investment, output, and the financial system.

So as I say in the speech that you mentioned, we've been building our capability to analyse these risks, and then working to embed that analysis in the day-to-day of what we do at the Bank of England. And where necessary, tailoring the response to the particular policy function that we have. So for example, in monetary policy, it's about understanding shocks to inflation and output. In supervision, it's about how banks and insurers manage climate-related risks. And for financial stability, it's about the system-wide amplification of those risks. So as the speech says, I think we've made a lot of progress in these areas in the past few years and we've got more to come. So I'd argue that's a pretty big increase in our capability in these areas.

Jason Mitchell:

That's some great context. You've made some really interesting points. Now, there's a lot of debate about the line, the exact line, between central bank action and government climate policy. Indeed, your BOE colleague, Sarah Breeden, has said that the BOE needs to stay in its, quote, "swim lane," which is interesting when it comes to climate and shouldn't engage in the political debate around net zero. Let's talk about that swim lane. How do you maintain that discipline in that swim lane when the macroeconomic implications of climate policy are inherently political in and of themselves? Is there ever a risk that that swim lane becomes too narrow? I guess what I'm asking is how does the bank avoid mission creep while still factoring climate impacts into its mandate?

James Talbot:

Yeah. So look, I think the first thing to say is that central banks are climate policy takers. We're not climate policymakers. Climate change is a matter for publicly elected officials. So when we talk about the swim lane and how we define that really as our objectives as a central bank, which are set by Parliament and our policy committee remits are given to us by the government.

So as I said previously, if climate-related developments affect those objectives, then we as a central bank need to understand how. And so really our role is to assess how climate change and the climate policy choices made by the government affect the economy, financial stability, and the firms that we supervise and regulate. And where those effects are material, then we need to act appropriately.

So let me just give some examples. So for the MPC, we need to understand whether climate change affects inflation and output over the next two to three years, as well as whether it affects the supply side of the economy when we're setting interest rates. For the financial policy committee at the bank, it means identifying, monitoring, and where appropriate, addressing systemic risks that could affect the resilience of the financial system. And for the Prudential Regulation Committee, it means ensuring banks and insurers manage material climate-related risks safely and soundly.

And I think really that's the logic behind the approach I set out in the Measure, Model, Tackle, Tailor speech. We measure the exposures, we model how they could affect the economy and financial system, we tackle the material risks that are within our responsibilities, and we tailor the response across the policy functions. So I would really frame this as central banks applying existing objectives to a changing risk environment. And so in this regard, I think climate risk is really one of a number of new risks that we have to understand and assess the materiality of.

Jason Mitchell:

Yeah. When you talk about central banks like the BOE actively integrating climate risk, maybe a naive question, but what really does that look like? What weight does climate risk carry in the overall, I'd say, decision-making process? And how is the BOE addressing different temporal objectives like near-term price stability versus long-term climate risk?

James Talbot:

Yeah, great question, and happy to unpack this. And I'll kind of go through the different responsibilities that we have, and maybe I'll start with monetary policy. So I think really the key on the monetary policy side is working out how climate change affects inflation and output in the near term. And actually, we've just published a new body of work in the Network for Greening the Financial System examining exactly these questions, and I can come back and talk more about that later. But just to give one example now, I think there's growing evidence that climate change is affecting food prices, which matter a lot because everyone buys food. Although the UK is probably less susceptible to the physical effects of climate change than many other countries, severe weather events can generate large price increases in global agricultural commodity prices. And of course, we're an economy that imports a high proportion of our food, around probably 40%. And so UK inflation is susceptible to these changes in global commodity prices.

There's an interesting study that's been published recently for the Euro area that showed, for example, that for every 1% increase in globally traded food prices, overall inflation rose by 0.1%. And we've done some work ourselves at the Bank of England on the effects on the UK economy, and essentially the effects are broadly similar. And in addition, we've also done work which suggests that food prices are particularly important informing people's inflation expectations, which again, is really crucial for monetary policy.

Then on the supervisory side of things, so we first set out our expectations of how banks and insurers should manage climate-related risks in 2019. And essentially what we said is we want banks and insurers to treat these risks like any other operational or financial risks that they'd manage. That means clear senior ownership, information flowing to the board, and evidence that climate considerations are shaping strategy and day-to-day decisions.

To come back to your horizon point, banks are often making long-term decisions when they choose to lend. And so understanding the impact of climate change on their own business model is really important in that context. And late last year, we clarified and updated our supervisory expectations in this area, and we're now working with the firms that we supervise to work out how they can embed those expectations into what they do. And I think a key next step here is investment in climate scenario analysis capabilities, tools and best practise, to enable firms to model these risks to their business models from climate change.

And then turning to the financial system as a whole, it's an obvious point, but financial stability is often more than the sum of its parts. And so we're looking at how climate risk could amplify stress across the financial system. And there are many channels here, and we laid some of these out in our financial stability report in November 2024, and we also updated our thinking on this at the end of last year.

And I think the bottom line here is there's obviously considerable uncertainty over when climate-related risks will crystallise, but we do know that these risks have the potential to be important. So to take one example, if insurance provision is removed because of an increase in extreme weather events, or if financial markets reprice assets in the realisation of how they're likely to affect climate-related risks, then that can have an effect on the system as a whole.

And then the final word I'd say on this in terms of what we're doing at the Bank of England, we're also trying to improve our assessment of the climate-related financial risks on our own balance sheet. So to give an example of this, we're increasing the insurance, or the so-called haircuts on the collateral that we take in our central bank lending operations, where these assets are more susceptible to climate risk. And really, I think the way I'd portray that is it's simply the sort of prudent risk management that we'd expect from any other financial firm trying to manage these similar risks.

Jason Mitchell:

Really, really interesting. I definitely want to come back to the point around insurance a little bit later. But first, you've warned that markets could already be underpricing climate risks to corporate borrowers. Say more about this. Does that imply that a climate Minsky moment is more inevitable rather than theoretical? And how worried are you that that shock could propagate through non-banking channels that sit outside prudential regulation?

James Talbot:

Yeah. So I'll come back here to the analysis I mentioned from our financial stability report. And as you said, that suggests that climate risks may not be fully priced into the value of corporate and sovereign bonds. So I think the thing I'd say is that doesn't necessarily mean a Minsky moment is inevitable, but if risks remain underpriced for a sustained period, any adjustment will certainly be sharper if or when markets choose to reassess those risks.

Now, of course, an orderly adjustment is much better, but I think what we need to look at is previous stress episodes have shown us that short, sharp shocks to asset prices can happen. And so that's why we've been focused on building the system's capacity to recognise and manage climate-related risks before they crystallise. I think here, better measurement and disclosure of these risks will help as we're deepening the use of scenario analysis, which all of these things will help ensure that market participants have the information and the tools they need to address risks in a forward-looking way.

And so from a financial stability perspective, as you said, the other key question is whether and how this shock can be amplified by the broader financial system. And we know that risk can travel through asset prices, funding conditions, investor behaviour. We know that leverage, liquidity mismatch, correlated exposures, market dynamics, and the behaviour of investors under stress can all contribute here. And so that's why our financial policy committee at the Bank of England spends time understanding the risk dynamics and building resilience in order to reduce the risk that any eventual adjustment is disorderly. And that's why we wanted to put that analysis out in our financial stability report.

Jason Mitchell:

Got it, got it. Your framework in the LSE speech begins with measure, and after all, what's measurable is manageable. But the reality is climate data is still largely patchy and consistent and obviously backwards looking. Given the UK's adoption of ISSB, I think that's SRS now, and in terms of the standards, how far are we from having the data infrastructure that would actually make your framework operational at the kind of granularity you need?

James Talbot:

Yeah, I mean, I think data's really important. So what I'd say is we're making progress on improving climate data, but this challenge isn't solved, and we need to keep working on it. And you're right. I mean, the reason I started the framework with measure is because good decisions depend on good information, frankly. And if you can't measure risks, opportunities, and outcomes consistently, it's pretty difficult to allocate capital as an investor or to make informed policy choices as a policymaker.

So I think what we need is good and consistent climate disclosures across the economy. These will play an essential part in helping firms identify and measure risks, and ultimately take better decisions. And to that end, we've been a strong supporter of both the ISSB international standards and the UK process to implement those, which you mentioned. And what we'd hope here is that this will give the market participants the information they need to price these risks accurately.

In addition, I'd also mention a few places where we've been trying to tackle data gaps ourselves. So the first thing we've done is we've tried to bring together different groups, so climate scientists, academics, policymakers, firms, regulators, because better integration of evidence across disciplines can strengthen the quality and robustness of climate risk assessments.

And one example of this is we've been doing some work recently with the Met Office because they have a lot of great data on the effect of weather and physical risks. And what we've really been trying to do is to see whether we can use that data to help us get a better handle on physical hazards and how they play into financial risks.

In addition, we're also really keen to work with industry as well. So we've co-convened with the Financial Conduct Authority, the Climate Financial Risk Forum with many, many financial participants. And we've also contributed to the international work in this area through bodies such as the Basel Committee, the NGFS, as I mentioned earlier.

What I would say though, is that I think it's important not to let the pursuit of perfect data become an excuse for inaction. Policymakers, investors, and firms always have to make decisions under uncertainty. So I think the key question is whether the information we have available today supports better decisions than it did before. And I think the answer's yes, but there's still further to go.

Jason Mitchell:

That's a really good point. And by the way, I wholeheartedly agree with you on the point about data. But I want to pick up on one of the central themes of your work in both your LSE speech and another speech, your Oxford speech titled The Heat Is On: Why Monetary Policymakers Are Increasingly Focusing on the Impact of Climate Risks.

And in both of those, it seems to be that physical climate shocks will increasingly look like the supply side shocks that drove the post-pandemic inflation surge. And back then, central banks really struggled to get ahead of the post-COVID inflation surge, which was partly a supply shock. By the way, it'll also be interesting to see how central banks deal with the current Hormuz energy supply shock. Again, given that central banks have historically, at least typically, dealt with demand side shocks, not supply side shocks. But what gives you confidence that the BOE's existing framework will be nimble enough to distinguish climate-driven inflation from other supply pressures and end up responding appropriately, especially if these shocks become, let's say, layered and persistent?

James Talbot:

Yeah, so there's no doubt that we live in an era of frequent supply shocks. Several members of our monetary policy committee have talked about this in speeches, including the governor. This is a key reason, I think, why inflation's been above target for much of the past five years in the UK, and it's one of the reasons why we commissioned an independent review of our forecasting by Ben Bernanke, former chair of the Federal Reserve.

So in addition to that though, I think the work that I've been doing in the Network for Greening the Financial System suggests that climate-related shocks can often manifest to supply shocks, as you said in your question. And I think this is true for both physical risks and also for the impact of the transition as well. So for example, a physical shock can destroy capital or transition policy can reduce investment in high carbon capital, for example, which is the whole point.

Supply side shocks though, I think, are particularly challenging for monetary policymakers to manage because essentially they push up on inflation and down on output. And that generates a trade-off between stabilising inflation and supporting output. And I think typically here, for a one-off shock, what you would say is, well, we look through that shock because it's impossible to stabilise inflation immediately.

But I think the key thing is we need to make sure that inflation doesn't take hold in the system. So preventing the second round effects that policymakers often refer to. And I think here the key insight really is that that challenge will get harder as climate-related shocks become more frequent and more severe. And so that's the reason actually why we've done so much work on this issue in the NGFS. So for example, we published a report earlier this month setting out a framework to aid monetary policymakers as they think about the potential impacts of these shocks.

And that builds on some previous work that we did in the NGFS to describe the transmission of climate shocks and how to model them, as well as some empirical work that we've done to quantify their impacts. And I think those resources that we've built up in the last four years in the NGFS are really resources that all central banks, including the Bank of England actually, can draw on. And here I think we can build on our own internal framework for assessing supply side shocks, which we're already using at the moment to assess the impact of the conflict in the Middle East, as you mentioned.

Finally, I would say, as you also said, judgments around the scale and persistence of second round effects are always challenging. And so we need to really, I think, here draw on a range of different modelling and analytical approaches where we can.

Jason Mitchell:

I want to stay on the speech for a little bit longer because you also noted that the BOE's analysis suggests that climate transition policies were, quote, "probably more important contributors to recent movements in inflation than we previously though." In my opinion, that's pretty striking. It's also refreshingly honest, but maybe unpack that a little bit more. What did the BOE's conventional forecasting miss, and how has climate scenario analysis changed the way the bank now approaches its inflation projections?

James Talbot:

Yeah. So in the past few years, energy prices have mainly been driven by big global shocks like Russia's invasion of Ukraine and the recent conflict in the Middle East. And those hard to forecast geopolitical events have been a really big contributor to upward moves on inflation and also errors in our inflation forecast. And we published some work last year where we go through and decompose the inflation forecast errors that we've made.

But I think the insight that you're referring to is that, at the same time, carbon prices in the emissions trading scheme have also been rising. And so while these transition policies, the other energy market developments that I mentioned, and the broader macroeconomic environment can of course interact in ways that are hard to disentangle in real time. We've done some research that suggests changes in carbon pricing do matter for inflation dynamics. And so I think my colleague Sarah Breeden showed some analysis in a speech on this where what she showed was that energy price rises due to a carbon permit supply shock in the ETS can have a larger and more persistent effect on inflation per unit than a more traditional energy price shock.

And I think that makes sense to me because carbon prices do need to move upwards over time. And if everyone knows that, then people start to factor that into their expectations. A few other members of our monetary policy committee have also given speeches in this area. There's a really great speech actually by Catherine Mann in 2023 where she talks about the impact of the emissions trading system on inflation as well.

And I think really, overall, this analysis underlines for us that we need to stay focused on these issues in the future. And it's an example I think of how models of the economy based on historical outcomes and relationships could miss changes in the structure of the economy that could be relevant for future policy. If we think climate change is evolving over time, then this falls into that bucket.

One point I did want to be clear on here though, is that although the climate transition creates changes in economic activity and prices that central banks need to respond to, we're not complaining that our lives are being made difficult here. Essentially, while these policies may present this trade-off for us in the near term that we need to deal with, there's an increasing body of evidence that says that the economic costs of climate inflation will be far greater in the long run. So our successors will be dealing with bigger issues if we don't do this transition.

But also actually in addition, I would add another point, which is that I think there is increasing evidence of positive short run economic effects from the climate transition as well. So let me mention a couple of things here. So as renewable energy is generated and sold under fixed price contracts, household bills should become less exposed to oil and gas price shocks, helping to reduce inflation volatility.

And there's a really nice speech actually from the ECB's Philip Lane earlier this year where he shows some evidence. He looks at electricity prices following the big shock in 2021, 2022 after Russia's invasion of Ukraine. And then he also looks at the reaction to the latest energy shock that we've seen this year. And what he finds is some interesting evidence of this time round, the shock is more muted in countries that have a higher share of renewables or nuclear in electricity generation.

And so I think really what this points to is we need to take stock of this recent experience and we are starting to refine the way that we do our inflation forecasting to take these sorts of things into account. And I think you also alluded in your question to this idea of using scenario analysis in monetary policy to look at the sensitivity of the outlook and future to different climate policy paths. And that's exactly what we did in the report that we published earlier this month.

So we did a collaboration between the NGFS and the IMF. We used the IMF's global model with climate to study the impact on inflation and output of governments' nationally determined contributions under the Paris Agreement. Now that work showed that, while these effects aren't big right now for most countries, they can still create these trade-offs for monetary policy to manage. And in addition, the size of those trade-offs really depends on policy design, credibility, and the structure of the economy.

So I think overall, my message here would be that we as central banks need to be more alert to these types of relative price changes as part of our forecasting and scenario analysis, particularly as we hope decarbonization effects pick up in future.

Jason Mitchell:

Absolutely. I do want to come back to those two NGFS papers and dig a little bit more into it. It's interesting on the transition point, and perhaps it's the long shadow of Mark Carney, his sort of legacy, but central bank climate work seems to historically been framed around this transition to net zero. Given the physical risks that are already locked in, should central banks be thinking more systematically about adaptation? Do you think the financial system currently has the tools to price and finance adaptation at the scale needed?

James Talbot:

Yeah. So I mean I think the transition remains essential. But I would agree with you that adaptation also needs to be part of the conversation. So as I set out in the speech that you mentioned earlier, climate change is no longer just a long run issue. Physical impacts are intensifying and are increasingly being felt today. So resilience and adaptation do matter for both the economy and the financial system.

And to take your point on adaptation, I think this matters because it can reduce the economic and financial impacts of physical climate risks when they crystallise. So for example, better flood defences, more resilient infrastructure, property level resilience measures, better planning can all reduce future losses. And that matters for households and businesses, but also for insurers, lenders, and the wider financial system.

But I think the other thing is we need to be clear about roles here. So the government has the central role in thinking about adaptation policy. It takes decisions on planning, infrastructure, flood defences, public investment. But those choices will shape the risk environment in which households, firms, and insurers, and lenders operate. And that's where we come in.

So the financial system I think can support this, but it can't deliver it on its own. Insurance, lending, capital markets, risk modelling, and disclosure can help transfer risk and finance resilient investments. But many adaptation investments have public good characteristics. And so they'll have long payback periods or benefits that are hard for private investors to capture fully. And I think that probably means that public policy and private finance need to work together on this.

But I think as a central bank, really our role is to understand how physical risks and adaptation gaps could affect our objectives. And in order to do that, we need better information on physical hazards, exposures and vulnerabilities, and better modelling of how those risks could transmit through insurance, credit, collateral values, asset prices, and to the real economy. And that's difficult because physical risks are often localised. They're also uncertain as well.

And I think insurance is a really good example actually of why adaptation matters. So as physical risks intensify, that will no doubt affect the availability and affordability of insurance. And adaptation can definitely support insurability by reducing expected losses and also making these risks more manageable for insurers.

But of course, if adaptation's not sufficient and insurance protection gaps widen, the risks don't disappear. They will shift somewhere. So they'll shift to households, to businesses, to lenders, or even in some cases, the public sector. So in terms of whether the financial system currently has the tools to finance adaptation at the scale needed, I would say there probably are some gaps. And so really, I think what we need to do is work on incentivizing adaptation, and that requires really better information, as I've said. But also financing adaptation will also require investible projects, clear incentives, and probably a public policy framework that makes resilience investment viable. And I think as societies, we're going to need to think more about these issues in future.

Jason Mitchell:

Yeah, it's such a fascinating topic, and I think there's a real imperative to kind of build this out. I think in the last podcast episode, two episodes ago with Professor Nicola Ranger at LSE, I guess what it sort of revealed was there certainly is a lot of work at the micro level, a sort of understanding the relationship between asset pricing and a firm's resilience to different individual physical risks across acute and chronic risks. But I guess there's this sort of open question of what that means from a systemic kind of risk perspective, particularly the cascading risks across markets, asset classes, et cetera, that you just kind of referred to.

You mentioned the flood point, and I really wanted to kind of push you on this, because in the past I've seen that you've highlighted that as many as 6.3 million properties in England sit in flood risk, rising to eight million by 2050. But Flood Re, which keeps insurance affordable, ends in 2039, which is well within the lifetime of a mortgage. This feels like a real tangible example of the kind of physical risk that markets aren't yet really pricing. What is the UK doing to prepare for this cliff edge? And if insurance ultimately retreats at scale, what could the contagion pathway look like in terms of house prices, the bank balance sheets, financial stability more broadly?

James Talbot:

So as we just discussed, I think this is mainly an issue for the government rather than for central bank policy. But as you say, Flood Re supports the affordability and availability of insurance for households in areas at high risk of flooding. And as you also say, it's designed as a temporary measure and will end in 2039. And part of Flood Re's mandate is to set out a transition plan to ensure we have a UK market where households at risk of flooding can still obtain affordable home insurance after that date. And that will include actions to reduce the risk, damages, and costs of flooding, as well as to find market-led solutions to tackle these risks.

So Flood Re recently announced a new package of reforms which have been designed to improve affordability, fairness, and resilience as part of that transition. And these reforms will hopefully strengthen incentives for property level flood resilience through new flood performance certificates, premium discounts for resilient homes, and also an expanded Build Back Better programme. So we're making progress. But the big issue I think remains making sure we don't end up in a situation where, as physical risks increase, these insurance protection gaps increase. I mean, in other countries, these insurance protection gaps are much bigger.

So I think really the key here is we need risk reducing actions. And for insurers, I would say that it may be prudent for them as individual firms to not offer as much protection in future or increase the price. But if this widens protection gaps, these losses will shift to elsewhere, as I said before. And so again, coming back to our responsibilities as central bank, and thinking about the financial system as a whole, we need to figure out what will happen.

And you mentioned some modelling that we've done, and that suggests that, under pretty conservative assumptions, the share of UK mortgages uninsured could increase from around 5% today to potentially between 7 to 10% by 2050, or even up to 16% following a severe flood event. So that's obviously a significant proportion. And if that were to happen, then what's likely to occur is that house prices will fall for the most exposed households, and that will really reflect the fact that they'll have higher insurance premium in future, the possibility of flood damages, and that could mean that there's difficulties in terms of getting mortgages for those properties. And so aggregated across the UK, our modelling suggests that we could see house price falls, we could see increases in mortgage impairments for banks.

Now, when we look at that, this is pretty small relative to the huge macro stresses that we use in our regular stress tests, but it's still something that we need to consider. And I think that doesn't mean the issue is trivial. So not least because the consequences for affected households, lenders, and local economies could be pretty significant. And given the relevance of protection gaps to many stakeholders, I think industry collaboration will be needed to reduce the chance that physical risks spill over into the wider financial system.

Jason Mitchell:

Super interesting. I'll definitely be tracking that. But I wanted to change lanes and come back to the NGFS, which you've obviously been pretty involved with, and which has grown from eight to, I think, over 130 members in the last decade. That's pretty remarkable convening power among central banks. But as we know, convening isn't necessarily the same as acting. So what in your mind has the NGFS changed to influence how central banks approach climate risk? Where's the gap between the scenarios the NGFS publishes and what central banks themselves are actually doing with them?

James Talbot:

So when we helped to found the NGFS 10 years ago, central banks were still pretty new at thinking about climate risks. And I think at that point, the initial task was to establish why climate change was relevant at all to central banks. It was often seen as a long run issue rather than something that could affect inflation, output, or firm resilience or financial stability.

But as I said earlier, I think considering the impact of climate as a central banker is now more mainstream. And I would say a large part of that is down to the work of the NGFS, the Network for Greening the Financial System. And as you said, the membership has expanded hugely. We've got a really large number of central banks and regulators now involved.

And what's really interesting when you sit down and talk to those other central banks and regulators is that many of them are facing the day-to-day challenges of dealing with climate change. And so there's a lot of appetite, I think, on the part of central banks to do something and to change the things we do in light of this.

So while the NGFS isn't a standard setting body, and it's not mandatory to implement any of its guidance, I think it provide a really useful platform for providing the public goods that central banks need to respond to the challenges they're facing. And actually, we published a new strategy for the NGFS just last week, and that's really centred around three strategic priorities as we move forward.

So the first is being a technical incubator for innovative work on climate and nature-related risks, which has always been what the NGFS has tried to do. But secondly, there's a real focus on building capacity amongst the membership and helping central banks to translate this technical work into operational tools. And thirdly, the NGFS is also trying to strengthen its role as a centre of expertise on climate scenarios, including supporting practical implementation. And so when you look at those priorities, the second priority I think is exactly what you're getting at in your question, making sure central banks can take actions in practise. And the third priority speaks to your specific question on how scenarios are used in practise.

So let me just say a quick word how we're thinking about using scenarios at the Bank of England. And I pointed to three things. So first, in 2021, we did a climate exploratory scenario to assess the resilience of the UK financial system in the long run. And that work found that a timely well-managed transition path keeps system costs lower relative to late or no action pathways. And I think that was a really useful exercise to get financial firms having a look at these types of scenarios.

Second, we're now also using scenario analysis to help understand the climate risk on our own balance sheet. And actually we report this now in our annual climate-related financial disclosure. And there's more detail on how we use scenarios at the Bank of England in a Quarterly Bulletin article from 2024. Third, as I flagged earlier, we used the NGFS scenarios in our financial stability report last year to assess the potential FS implications if investors were to reprice financial assets rapidly to reflect climate risks.

But I think the key thing now is focusing on ensuring that banks and insurers are also making practical use of climate scenario analysis. And really what we want here is we want firms to tailor scenarios to capture all material climate-related risks that are relevant to their business model. And we set out our expectations here in this new supervisory statement that we published last year. So in other words, I think what we want to do now is to ensure that these tools are sufficiently practical, decision useful, and embedded in day-to-day risk management processes. And in order to do this, as I mentioned earlier, we're working with these firms as part of the Climate Financial Risk Forum.

Jason Mitchell:

I wanted to come back to the two papers, the two NGFS papers that you mentioned, which you chaired, one on climate mitigation and monetary policy with the IMF, and another on central bank strategy. And tell me if I'm misreading this, but to what degree do they represent a sort of a bind? As physical climate shocks become more frequent, it gets harder for central banks to simply look through the inflation. But the joint modelling with the IMF seems to show that when central banks actually do end up responding aggressively, they bring inflation closer to target, but at the cost of greater output losses. In other words, it kind of seems to cut both ways. Fiscal shocks you can't ignore and transition policies that could end up creating supply side wedges. So how should a central bank decide when looking through is the right call and when doing nothing becomes the more dangerous choice?

James Talbot:

Yeah. So we talked a little bit about this earlier in the podcast, but I think essentially these reports are really about judgement under uncertainty for central banks. We're not trying to say central banks should always respond more aggressively to climate shocks. Equally, we're not trying to say central banks should always look through them. I think looking through these shocks can be the right response when a shock's temporary. Inflation expectations remain anchored and where second round effects are limited.

But I think looking through becomes harder when shocks become more frequent, more persistent, and they also affect salient prices in the sense of food that I mentioned earlier. And that can then feed into expectations on wage or price setting behaviour. And I think really the sort of key thing for me is that, as climate-related shocks become more frequent or will become more severe, then the balance will probably shift in terms of central banks needing to take action in response.

And there's a really good example, I think, in one of the NGFS reports, which looks at what happened when the really terrible floods hit Pakistan a few years ago. And obviously when that happened, it created really severe economic disruption in the economy, but it also pushed up inflation a lot. And so actually what that meant is that the central bank in Pakistan had to raise interest rates quite significantly. And I think that quite neatly illustrates the trade-offs that we could face in response to these physical risks.

And the modelling work that we've done with the IMF that I mentioned earlier, I think illustrates that trade-off, also for transition policies, as you've said. Now, as that paper says, these are not huge right now, but they could increase as countries ramp up transition policies. And I think there's also an important message actually in that report that says that what we need to do is ensure these climate transition policies are well understood. Because if firms and households understand the transition path, then they can more easily adjust to them. And we show some evidence in that paper that this can reduce the difficult trade-off that central banks have to manage.

But I think sort of bringing this together, all of that work shows that, as central banks, we need to be prepared for different scenarios, and we need to react to the shocks that we face, whatever they are, in order to deliver low and stable inflation, which is what we're here to do. I think it also underscores the value to central banks of the work we've been doing in the Network for Greening the Financial System. And that work really helps us to think about how these shocks might transmit. It's helping us to improve our modelling of their impacts. We've quantified some of those impacts, and we're now setting out how we think central banks should respond as well.

Jason Mitchell:

Interesting. Let me push you a little bit more on this. I mean, what should the response look like if a central bank decides it can't look through a climate shock? The NGFS guide talks about adapting monetary policy strategy, but central banks still have the same core instruments. In other words, rates, forward guidance, and balance sheet tools. Do you think these are enough to address persistent supply side shocks from physical climate events and transition policies, or does the framework itself need to kind of evolve more?

James Talbot:

Yeah. I mean, I think the first thing that we need to do is to start by understanding the nature of the shock. And so I think a key distinction for policymakers is whether the climate-related shock remains just a relative price shock, or whether it evolves into more broad-based inflationary pressure.

And as I mentioned earlier, I think where these shocks affect things like energy and food prices, this typically begins by raising the prices of a certain set of goods. Now that alone may not necessarily warrant a monetary policy response. We can't stabilise inflation immediately. But I think the central question is whether those relative price changes propagate into generalised inflation through firms passing on higher input costs along supply chains. Obviously forecasting those effects is pretty challenging, and it will depend on a number of things. But if persistent second round effects are expected, then a monetary policy response will be required.

And I guess I would argue that monetary policymakers could then respond in the same way that they would to any other shock. So we can raise interest rates or we can give guidance about future interest rate paths, as you said. So I guess here I would argue we do have the tools that we need, even if the judgments on how to use those tools are pretty difficult in practise.

And I think in the UK, for example, we do have an option to flex the horizon over which inflation's brought back to target. That's a part of the framework that we have. Obviously if we did that, we'd explain our reasoning publicly. We'd have to write to the chancellor to explain why inflation was away from target as we have done in the past. But I think really the absolutely key thing for me here is to understand the impact of these shocks and to do more work in this area. And again, I think that's where the work that we've done in the NGFS will help us.

Jason Mitchell:

Absolutely. Last question, and let me kind of finish it off with the NGFS strategy report, which ends with kind of a practical step-by-step guide for central banks responding to climate shocks. In other words, identify, assess, respond, communicate, and monitor. The sceptic would say that that reads as basically an acknowledgement that most central banks don't yet have a playbook for this. In your perspective, how far away are central banks from actually being operationally ready for a world where, call it climate shocks, are a regular feature of monetary policy? What grade would you give central banks as a whole in achieving this?

James Talbot:

Yeah, so I think this is a good challenge. And as I said in my speech at the LSE earlier this year, I think the area of monetary policy is the most nascent part of considering how climate change affects what we do as a central bank. And I think really that's because we've tended to think of climate change as a long run issue, but the monetary policy horizon is typically short. Usually we're looking at what's going to happen in the next two to three years.

But really our focus is beginning to intensify for exactly the reason that you outlined. As we begin to see climate change affecting the economy in the short run, those impacts become relevant when we're setting monetary policy. And I think as well, we've also been getting a pretty consistent message from the NGFS membership, particularly from those members who are already experiencing the acute effects of climate change, that we need to start thinking about these issues.

So this is why we've been building this body of work. And we started with a conceptual framework to think about how physical impacts and transition policies can affect the economy in the short run. Then we've also been working on how we model this in order to assist central banks in their assessment of the impacts of climate change. And more recently, we published the insights of our model in collaboration with the IMF as well as I mentioned earlier.

And it's also, back to the question you asked earlier, why we've made the new NGFS strategy deliberately practical. And also why in the monetary strategy report that you mentioned, we try to set out this framework and we try to put in the practical steps that central banks need to do. I mean, I think many central banks already analyse energy, food, supply chain, and weather-related shocks. I think the next step is to make the assessment of climate specific channels, and to make that more systematic in our forecasting scenario analysis, and our risk monitoring and communication as well, which is what the strategy report highlights. And I think it's fair to say that readiness here varies across countries. Some central banks have more data. Some have more modelling capacity and institutional experience than others. And of course, some economies are just more exposed to physical risk. And so central banks have had to develop the framework earlier.

But I think the positive message for me is that central banks can draw on existing toolkits here in doing this work. And we've been helping central banks around the world do this actually in the last 18 months. We've had the capacity building programme, which has been really superbly led by colleagues from the Bank of Spain and the Chilean Central Bank. And they've been working with modelling experts from a range of central banks. And what they've been doing is kind of taking the five or six climate models that we think are really good and essentially helping a range of other central banks to apply these models to the challenges that they're facing. And so really that's been kind of building our capacity to analyse these issues.

And I think the final thing I'd say is, and you asked me to give a grade, I mean, I'm really, really reluctant to grade my central bank colleagues. I think not least because I think we need to be humble about the state of our knowledge in the face of these huge uncertainties. But I think what I would say is I'd definitely give my NGFS colleagues an A+ for their effort based on the commitment and dedication that I've seen across a range of countries in the past few years through the work that we've been doing.

Jason Mitchell:

All right. What a great way to end. It's always good to end on a positive message. So it's been fascinating to talk about why climate risk has shifted from a long run abstraction into feeding into inflation, asset prices, and insurance coverage, how the Bank of England is responding across its monetary policy, prudential regulation, and financial stability functions, and what it'll take to ensure the financial system remains stable and price stability is maintained as the climate transition accelerates. So I'd really like to thank you for your time and insights.

I'm Jason Mitchell, CIO for Responsible Investment at Man Group, here today with James Talbot, executive director of the International Directorate at the Bank of England. Many thanks for joining us on a sustainable future, and I hope you'll join us on our next podcast episode. James, thanks so much for your time. It's been a super, super interesting discussion.

James Talbot:

Thank you very much.