The link is inevitable – price adjustment due to carbon taxes is smaller than adjustments due to typical energy shocks.

Rising inflation has once again become a primary concern for policy makers, markets, and the general public in advanced economies. The aftermath of the COVID-19 pandemic was marked by increasing energy prices, and was further exacerbated by the Russian invasion of Ukraine in 2022. At the same time, many countries have committed to de-carbonize their economies, giving rise to concerns around the economic consequences of the climate transition, in particular regarding inflation. In 2021, Larry Fink, CEO of Black Rock made headlines by predicting that policies against climate change would fuel global inflation.1 The European Central Bank (ECB) emphasized the consequences of climate change in its strategy review (see ECB 2021) and acknowledged that it could be forced to take “Greenflation”, that is, inflationary pressure arising from climate policies, into account in monetary policy operations (Schnabel 2022).

The uncertainty surrounding the economic effects of climate mitigation policies such as carbon taxes illustrates that they remain poorly understood. This paper attempts to shed light on the inflationary consequences of climate policy. We study whether past carbon taxes contributed to inflation, by drawing on a comprehensive set of carbon taxes and estimating dynamic impulse responses.

At first glance, oil price shocks might appear a close cousin of carbon taxes. A long literature has documented the contractionary and inflationary properties of oil price shocks (see, e.g., Hooker 2002; Barsky and Kilian 2004; Kilian 2008; Hamilton 2009), although the economic effects appear more muted today as a result of monetary policy credibility and fewer wage rigidities (e.g., Blanchard and Gali 2007; Blanchard and Riggi 2013). We argue that there are several features of carbon taxes that distinguish them from conventional oil price shocks and merit a separate analysis.

First, the magnitudes are vastly different: For illustration, consider the recent movements in European energy prices between January and August of 2022. The future prices of key commodities including natural gas, oil, coal, electricity, and diesel fuel increased substantially, between 34% for oil and 280% for electricity. Using commodity-specific carbon intensities (e.g., 2.08 tons of carbon dioxide (⁠CO2) per ton of coal), we compute an implied carbon tax that would mechanically elicit the same price response. Specifically, we estimate carbon taxes of $95 per ton for coal, $268 per ton for crude oil, $597 per ton for diesel fuel, $862 per ton for natural gas, and $1,838 per ton for electricity.2 In most cases, the taxes are orders of magnitude larger than the observed taxes in our data, as well as the estimates of the social cost of carbon, which tend to lie between $100 and $200 per ton (NGFS 2021). Moreover, these implied taxes send the wrong signals from a climate mitigation perspective, with higher implied prices for relatively cleaner energy sources. Similar calculations for the 1973 oil crisis lead to an equally sizeable implied carbon tax of $347 for crude oil.3 These examples illustrates that typical energy shocks lead to much larger price adjustments than even an ambitious carbon tax.

Second, energy price shocks are typically caused by sudden events that are not anticipated by economic agents. Instead, most of the carbon taxes are pre-announced well in advance with scheduled paths for future tax increases, such that firms and households are given time to substitute at the margins. Indeed, Andersson (2019) shows that the carbon tax elasticity of gasoline consumption is three times the price elasticity. Third, the effects of climate policy critically depend on design, including the tax rate and coverage, as well as revenue-recycling. Indeed a large number of carbon taxes are revenue-neutral, offsetting other existing taxes or re-distributing tax revenues. Unlike an oil price shock, it is therefore possible that the median firms’ and households’ tax burden is not affected by a revenue-neutral carbon tax. The lack of coordinated global climate policy has forced countries to implement national taxes, implying that in contrast to oil shocks the effects are confined to the domestic economy.