Effects of carbon pricing on inflation

Abstract

This paper provides ex-post empirical evidence on the effects of carbon pricing policies on headline consumer price inflation, as well as on its food, energy and core inflation subcomponents. It considers both carbon taxes and prices of carbon emissions trading systems (ETS) as carbon pricing policies, and a large number of OECD economies from 1995 to 2020. The paper uses dynamic panel estimation of New-Keynesian Phillips curves, which are commonly used for modelling inflation dynamics, and control for macroeconomic variables including the output gap, exchange rate changes and inflation expectations. An increase in prices of ETS by US dollar $10 per ton of carbon dioxide (CO2) equivalents is found to increase energy consumer price inflation by 0.8 percentage points, and headline inflation by 0.08 percentage points, but has no significant effects on food and core consumer price inflation. An increase in carbon taxes by $10 per ton of CO2 equivalents increases food consumer price inflation by 0.1 percentage points, but has no significant effects on energy consumer price inflation, headline and core consumer price inflation. These findings are relevant for future climate policies. They suggest that higher carbon taxes and prices of ETS permits have not led to large increases in headline inflation. Consequently, based on this evidence the use of carbon pricing to speed up the necessary transition to net zero carbon emissions need not be held back by concerns about large overall inflationary effects. This is relevant since these carbon pricing policies have been shown to be effective in reducing carbon dioxide emissions.

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