Climate policy path shocks lower inflation, stance shocks raise it

The research by Degasperi, Hamadi, Natoli, Nispi Landi, and Pallara identifies two distinct carbon policy shocks in the European Union Emissions Trading System.

A shock to the current policy stance acts as a cost-push shock, reducing industrial production and greenhouse gas emissions while raising headline HICP inflation.

Conversely, a path shock—representing forward guidance on the expected trajectory of decarbonization—reduces headline inflation by 0.2 percent and energy HICP by 1.0 percent.

The path shock depresses aggregate demand as households anticipate lower future disposable income, causing industrial production to drop by 0.5 percent and Brent crude prices to fall 5.0 percent.

To isolate policy dimensions, the authors extract principal components from surprises in emission allowance futures and critical metal term structures for zinc, copper, and nickel.

Structural scenario analysis shows that monetary policy easing plays a vital stabilizing role following a path shock.

Without central bank rate cuts, the decline in headline inflation and emissions would be three times stronger, while industrial production losses and unemployment spikes would double.

Furthermore, path shocks lower climate risk indicators, cutting media climate concerns by 10 percent.