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San Francisco Fed President Mary Daly defended the central bank's work on climate change, which has been criticized as overreach by some Republican lawmakers, saying the neutral interest rate could be pulled down if extreme weather boosts precautionary savings or slows labor productivity.

Insurance companies are already raising premiums and covering less property damage because of climate change risks in Louisiana, Texas, and California, Daly said, some of the most populous U.S. states. Those increased costs are also forcing a rethink about where to locate businesses and how profitable and creditworthy they could be, she added.

"As uncertainty rises, so does the desire for precautionary savings that can be used to offset or hedge against possible future losses," Daly said in the text of a speech to the Peterson Institute for International Economics. "While such behavior is a prudent response to greater risk, a change in saving behavior of a large number of individuals, both here and abroad, would contribute to a lower neutral rate of interest, or r-star."

Hotter weather that curtails outdoor work or triggers a shift in the economy that creates shortages of workers in new industries could also reduce labor productivity, she said.

FED MANDATE AND CLIMATE CHANGE

"This would only add to the structural factors currently depressing the neutral rate of interest and further curtail the Fed's ability to cut rates to combat economic downturns," she said. "Of course, there could also be offsetting pressure on r-star from increased investments to move to a more sustainable economy."

Daly suggested the Fed is obligated to understand the economic implications of climate change, a view that hasn't been embraced by some Republican lawmakers who have said it stretches beyond the Fed's traditional mandate.

Chair Jerome Powell recently appeared at a BIS event with the heads of the ECB and PBOC to talk about climate change, and drew a line between awareness of potential effects on the banking system and being clear that governments must take the lead on climate change itself.

Daly said that "as monetary policymakers, our job is to navigate this uncertainty. We need to anticipate the changes before us and understand their implications."