Carbon Prices and Inflation in the Euro Area

CarbonPricesandInflationintheEuroArea MaximilianKonradt,ThomasMcGregor,andFrederikToscani WP/24/31 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2024 FEB ©2024InternationalMonetaryFundWP/24/31 IMFWorkingPaper EuropeanDepartment CarbonPricesandInflationintheEuroArea PreparedbyMaximilianKonradt,ThomasMcGregorandFrederikToscani* AuthorizedfordistributionbyOyaCelasunFebruary2024 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Whatistheeffectofcarbonpricingoninflation?ThispapershowsempiricallythattheconsequencesoftheEuropeanUnion’sEmissionTradingSystem(ETS)andnationalcarbontaxationoninflationhavebeenlimitedintheeuroarea,sofar.Thisresultissupportedbyanalysisbasedonapanellocalprojectionsapproach,aswellaseventstudiesbasedonindividualcountries.Ourestimatessuggestthatcarbontaxesraisedthepriceofenergybuthadlimitedeffectsonoverallconsumerprices.Sincefutureclimatepolicywillneedtobemuchmoreambitiouscomparedtowhathasbeenobservedsofar,includingtheneedforlargerincreasesincarbonprices,possiblenon-linearitiesmightmakeextrapolatingfromhistoricalresultsdifficult.Wethusalsouseinput-outputtablestosimulatethemechanicaleffectofacarbontaxconsistentwiththeEU’s‘Fit-for-55’commitmentsoninflation.Therequiredincreaseofeffectivecarbonpricesfromaround40EuropertonofCO2in2021toaround150Euroby2030couldraiseannualeuroareainflationbybetween0.2and0.4percentagepoints.Itisworthnotingthattheenergypriceincreasescausedbytheriseintheeffectivecarbonpriceto150Euroissubstantiallysmallerthantheenergypricespikeseenin2022followingtheinvasionofUkraine. JELClassificationNumbers: E31,E50,Q54,Q43 Keywords: Greentransition;carbontaxes;climatepolicy;inflation Author’sE-MailAddress: maximilian.konradt@graduateinstitute.ch;TMcGregor@imf.org;Ftoscani@imf.org *Konradt(GenevaGraduateInstitute);McGregorandToscani(IMF).WearegratefulforusefulsuggestionsfromseminarparticipantsatEuropeanCommission,EuropeanCentralBankandInternationalMonetaryFund. WORKINGPAPERS CarbonPricesandInflationintheEuroArea MaximilianKonradt,ThomasMcGregor,andFrederikToscani Contents ExecutiveSummary4 I.Introduction5 RelatedLiterature8 II.ThreeDecadesofCarbonPricingintheeuroarea10 Nationalcarbonpricing10 EmissionsTradingScheme(ETS)11 III.DataandEmpiricalStrategy12 Data12 EmpiricalStrategy15 IV.AggregateResults16 NationalCarbonTaxes16 CombinedImpactofNationalCarbonTaxesandtheETS19 Robustness21 Cross-countryheterogeneity22 V.CaseStudies23 VI.LookingAhead:MechanicalEffectsofFutureClimatePolicyonConsumerPrices25 VII.Conclusions29 References31 AnnexI.AdditionalTablesandFigures34 AnnexII.GTAPtoHICPmatching38 FIGURES 1.ETSFreeAllowancesandSurrenderedUnits,2005–2112 2.NationalCarbonTaxesintheEA,1990–201914 3.EUETSPriceandCoverages,2005–1914 4.DynamicImpulseResponsesofInflation(inp.p.)toNationalCarbonTaxes18 5.DynamicImpulseResponsesofInflation(inp.p.)toNationalCarbonTaxesandETS20 6.DynamicImpulseResponsesofPriceLevel(inp.p.),toNationalCarbonTaxesandETS20 7.RobustnessTests22 8.ImpactofCarbonTaxesonPriceLevelConditionalonMacroeconomicEnvironment23 9.EventStudies25 10.CarbonPricePathUnderFit-for-5528 11CumulativeEffectsofCarbonTaxonConsumerPrices,EuroArea28 TABLES 1.NationalCarbonTaxes13 2.EnergyInputs,CarbonIntensitiesandPrices,202127 ExecutiveSummary Thereisbroadconsensusamongpolicymakersthatnetcarbonemissionsneedtobereducedtozerobymid-centuryinordertomitigatecatastrophicclimatechange.Inlightofthisurgency,andthemanycommitmentsmadebygovernments,understandingtheeconomiceffectsofclimatepolicyisapriority.Inthispaperwefocusonwhethercarbonpricingaffectsinflationintheeuroarea.Wecarryoutthreetypesofanalyses. First,weestimatetheimpactoninflationofchangestothepriceofcarbonduetotheEmissionsTradingSystemandcarbontaxesintheeuroarea,usingapanellocalprojectionsapproachwithasetoffixedeffectsandmacroeconomiccontrols.Wefindthatcarbontaxeshavenotcontributedmeaningfullytoinflationintheeuroareaduringtheperiodofanalysis,andwheretheyhave,theimpactislikelytohavebeenshort-lived.Ourresultsinsteadsuggestthatcarbontaxeschangedrelativeprices,raisingthecostofenergy,withoutasignificantoverallincreaseinthepricesofgoodsandservices. Second,weexploittwocasesinwhichcountriesexperiencedsignificantincreasesintaxratesoverashortperiodoftime.WeestimateeventstudiesbasedontheFinnishtaxrevisionin2011andtheFrenchcarbontaxenactmentin2014,byconstructingarespectivecounterfactualeconomywithoutacarbontax.Althoughconsumerpricesgrewslightlyfasterinthesecases,comparedtothecounterfactualeconomies,thedifferenceissmalloverafive-yearhorizonafterthetaxchange(0.15percentagepointsperyear). Third,wesimulatetheconsumerpriceeffectsofaneffectivecarbonpriceincreaseconsi