Carbon Prices and Inflation in the Euro Area

Carbon Prices and Inflation in the Euro Area Maximilian Konradt, Thomas McGregor, and Frederik Toscani WP/24/31 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 2024 FEB * Konradt (Geneva Graduate Institute); McGregor and Toscani (IMF). We are grateful for useful suggestions from seminarparticipants at European Commission, European Central Bank and International Monetary Fund.© 2024 International Monetary Fund WP/24/31 IMF Working Paper European Department Carbon Prices and Inflation in the Euro Area Prepared by Maximilian Konradt, Thomas McGregor and Frederik Toscani* Authorized for distribution by Oya Celasun February 2024 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. ABSTRACT: What is the effect of carbon pricing on inflation? This paper shows empirically that the consequences of the European Union’s Emission Trading System (ETS) and national carbon taxation on inflation have been limited in the euro area, so far. This result is supported by analysis based on a panel local projections approach, as well as event studies based on individual countries. Our estimates suggest that carbon taxes raised the price of energy but had limited effects on overall consumer prices. Since future climate policy will need to be much more ambitious compared to what has been observed so far, including the need for larger increases in carbon prices, possible non-linearities might make extrapolating from historical results difficult. We thus also use input-output tables to simulate the mechanical effect of a carbon tax consistent with the EU’s ‘Fit-for-55’ commitments on inflation. The required increase of effective carbon prices from around 40 Euro per ton of CO2 in 2021 to around 150 Euro by 2030 could raise annual euro area inflation by between 0.2 and 0.4 percentage points. It is worth noting that the energy price increases caused by the rise in the effective carbon price to 150 Euro is substantially smaller than the energy price spike seen in 2022 following the invasion of Ukraine. JEL Classification Numbers: E31, E50, Q54, Q43 Keywords: Green transition; carbon taxes; climate policy; inflation Author’s E-Mail Address: maximilian.konradt@graduateinstitute.ch; TMcGregor@imf.org; Ftoscani@imf.org WORKING PAPERS Carbon Prices and Inflation in the Euro Area Maximilian Konradt, Thomas McGregor, and Frederik Toscani MF WORKING PAPERS The Green Transition and Inflation in the Euro Area INTERNATIONAL MONETARY FUND 2 Contents Executive Summary ............................................................................................................................................ 4 I. Introduction .................................................................................................................................................. 5 Related Literature ........................................................................................................................................... 8 II. Three Decades of Carbon Pricing in the euro area .......................................................................... 10 National carbon pricing ................................................................................................................................. 10 Emissions Trading Scheme (ETS) ............................................................................................................... 11 III. Data and Empirical Strategy ............................................................................................................... 12 Data .............................................................................................................................................................. 12 Empirical Strategy ........................................................................................................................................ 15 IV. Aggregate Results ............................................................................................................................... 16 National Carbon Taxes ................................................................................................................................. 16 Combined Impact of National Carbon Taxes and the ETS .......................................................................... 19 Robustness .................................................................................................................................................. 21 Cross-country heterogeneity ...............................