Carbon Prices and Inflation in the Euro Area

IMF Working Papers, February 16, 2024

Source details

Research question: What is the effect of carbon pricing on inflation in the euro area?
Main conclusion: The consequences of the European Union’s Emission Trading System (ETS) and national carbon taxation on inflation have been limited in the euro area to date.
Methods used: panel local projections approach, event studies based on individual countries, and simulations using input-output tables.

Estimates indicate carbon taxes:
- raised the price of energy;
- had limited effects on overall consumer prices.
Evidence sources:
- panel local projections;
- event studies of individual countries.
Caveat: Future climate policy will need to be much more ambitious than observed so far, and possible non-linearities may make extrapolating from historical results difficult.

Scenario simulated: increase of effective carbon prices consistent with the EU’s ‘Fit-for-55’ commitments.
Required increase in effective carbon prices:
- from around 40 Euro per ton of CO2 in 2021
- to around 150 Euro by 2030
Simulated impact on annual euro area inflation:
- could raise inflation by between 0.2 and 0.4 percentage points.
Contextual comparison:
- 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.

Historical evidence suggests limited pass-through of carbon pricing to overall consumer inflation so far.
Because future carbon price increases implied by ambitious climate policy are larger, policymakers should:
- consider potential non-linearities in pass-through when assessing inflationary effects;
- account for mechanical second-round effects captured by input-output based simulations;
- weigh the simulated modest inflationary impact (0.2 to 0.4 percentage points) against broader climate and energy transition objectives.

Content based on "Carbon Prices and Inflation in the Euro Area", IMF Working Papers 2024/031.