Not All Temperature Shocks Are Alike: Disentangling Heat and High Temperature Shocks and Their Effects on Inflation in Australia

We study the effects of heat and high temperature shocks on inflation in Australia using monthly, state-level temperature anomaly data via two stages. In the first stage, we decompose temperature anomalies into orthogonal components using a structural vector autoregression with long-run restrictions. We justify the decomposition by establishing its equivalence to a spectral projection operator from a linearised singularly perturbed system, formally linking the decomposition to timescale separation in climate science. In the second stage, we estimate the dynamic effects of these shocks on inflation using smooth local projections. We find that both types of temperature shocks significantly influence inflation, with heterogeneous effects across categories, states and seasons, highlighting the macroeconomic importance of distinct modes of climate variability.