While the urgency for strict policy actions against climate change is widely recognised, the inflationary effects of the green transition are unclear. This column analyses the impact of climate change policies on the price level, distinguishing between different types of policy, inflation regimes, income groups, and regional/sectoral characteristics. The inflationary effects of green regulations are limited to carbon taxes, with larger impacts in developing economies, where inflation is already high, and in regions/sectors characterised by high emissions and low innovation capacity.
While the urgency of strict policy actions against climate change is widely recognised (Fornaro et al. 2024), scholars and policymakers have also emphasised the potential short-term costs of the green transition, including inflationary effects.
Do strict climate change policies lead to higher inflation?
Theory does not unambiguously answer this question. On the one hand, climate change policies may increase the costs of energy inputs. As the economy shifts to green energy, demand for clean energy sources increases, thereby putting upward pressure on prices if production is not yet sufficiently scalable. Furthermore, inflationary pressures may be driven by the increased demand for critical raw materials used to produce green energy. The energy transition may also generate structural changes in the labour market, with likely upward pressures on wages in the short term, as the demand for high-skill/green jobs – typically characterised by higher wages – tends to increase.
On the other hand, climate change policies may lead to a short-term decline in employment (Bettarelli et al. 2025), reducing consumption and investment, thereby creating downward pressure on inflation. In addition, they may reduce inflation by spurring green innovation and productivity (Albrizio et al. 2017).
In a recent article (Bettarelli et al. 2024), we extend and contribute to the current literature (e.g. Konradt, and di Mauro 2021, Känzig and Konradt 2023), which has mostly focused on advanced economies, by empirically analysing the impact of various climate-change-policy measures on inflation for a large sample of 177 advanced and emerging market and developed economies, 78 subnational territorial areas, and 17 sectors, for the period 1989-2022. Our rich dataset allows us to estimate the inflationary effects of climate change policies at different levels of granularity – from macro to region/sectoral levels – and to explore various sources of spatial and sectoral heterogeneity.
Carbon taxes are associated with a temporary increase in inflation; other green policies are not
Figure 1 shows that an increase of one standard deviation in carbon taxes at the country level – approximately equal to $5/tCO2 – increases the price level by about 0.7% one year after the policy shock, and by about 1.6% four years after. The effect slightly decreases in the remaining horizon, signalling a transitory impact of carbon taxes on inflation. Taking the average emission coverage of carbon pricing instruments as a reference (i.e. 25%), an increase in carbon price of $100/tCO2, on average in our sample, would imply a price increase of about 8% in the medium term.
Figure 1 The inflationary effects of carbon taxes
Notes: The graph shows the response of the price level (in per cent) to a one-standard-deviation increase in carbon tax (red lines), as well as 90% confidence bands (shaded areas). The x-axis shows years after the policy shock at t =-1.
In contrast, other types of climate change policies, including an emissions trading system, non-market-based climate change policies (e.g. emissions limits), or technology-support policies (e.g. subsidies for green innovation), do not exert any statistically significant effect on the level of prices.
The effect of carbon taxes is two times larger in developing economies and when inflation is already high
Next, we distinguish between (i) advanced and (ii) low- and middle-income countries. Results show that the inflationary effects of carbon taxes are positive and statistically significant in both groups, but they are three times larger in low- and middle-income countries (Figure 2). Moreover, in a context already characterised by high inflation (i.e. an inflation rate of about 7-8% or above), a one-standard-deviation increase in carbon taxes pushes the price level upwards by 4% at the peak. This finding is also consistent with models of nominal rigidities due to menu costs, in which the frequency of price adjustments is proportional to the underlying level of inflation (Karadi and Reiff 2019).
Figure 2 Effects of carbon taxes on price level, by income group
Notes: The graphs show the response of the price level to a one-standard-deviation increase in carbon tax instruments (red lines), as well as 90% confidence bands (shaded areas). The x-axis shows years (k) after the policy shock at t =-1.
Effects vary also across regions and sectors
The macro results mask significant heterogeneity across regions and sectors. Larger shares of emissions at the regional/sectoral level (such as those at the 75th percentile of the distribution) are associated with an increase in the price level that is about 0.5-1% higher than regions/sectors with lower share of emissions (i.e. those at the 25th percentile of the distribution). In contrast, in regions/sectors with high innovation capacity, the inflationary effect of carbon taxes is 0.4% smaller (Figure 3).
Figure 3 Effect of carbon taxes on regional price level: Role of emissions and innovations
Notes: The graphs show the differential effect (scaled using the interquartile range – i.e. the difference between 75th-25th percentile values) of a one-standard-deviation increase in carbon tax on regional price levels (red lines), as well as 90% confidence bands (shaded areas).
Policy implications
These results have key implications for policymakers and in monetary policy settings. While there is a pressing need and compelling case for well-designed climate change policies to address the social and economic costs of climate change, the potential inflationary effect of these reforms needs to be internalised. First, policymakers should consider the implementation of targeted compensatory mechanisms to offset the real income losses for households, particularly those in high-emissions regions/sectors. Second, the evidence that the inflationary effects are larger when inflation is already high suggests that climate change policies are best implemented when economic conditions are more favourable. Finally, our results suggest that the type of climate change policy matters: as (green) innovation is key to reduce costs of the green transition, policymakers could implement target policies to foster green R&D.
Source : VOXeu
