Model comparison reveals climate transition challenges for monetary policy
A new ECB working paper compares several multi-sector monetary models to analyze the macroeconomic effects of carbon-intensive energy price changes. The study focuses on the euro area and the United States, highlighting challenges for monetary policy in the green transition.
Temporary shocks, varied impacts
The study systematically compares large-scale, multi-sector monetary models from central banks and international institutions, including the BIS, Banco Central de Chile, Deutsche Bundesbank, ECB, European Commission, and Eurosystem.
These models assess the effects of temporary increases in carbon-intensive energy prices, revealing transitory inflationary pressures and output losses.
The euro area generally shows greater exposure than the United States.
While qualitative responses across models are largely similar, differences emerge in the timing and persistence of inflation, reflecting variations in sectoral price rigidities and production structures.
Monetary policy rules perform comparably in stabilizing inflation and output, but necessitate substantially different interest-rate adjustments, underscoring the policy trade-offs inherent in sectoral supply shocks.
Permanent shifts, policy dilemmas
Permanent increases in carbon-intensive energy prices lead to lasting declines in GDP and consumption across all models, with an average long-run output loss of approximately one percent.
The inflationary consequences of such shocks critically depend on monetary policy strategies and expectation formation.
If central banks immediately internalize the permanent decline in potential output, policy accommodation is limited, potentially leading to deflationary forces.
Conversely, a more gradual adjustment of perceived potential output results in stronger monetary accommodation and sustained inflationary pressures.
This highlights the central role of expectations in shaping real and nominal outcomes, fueling the debate on whether the green transition will be inflationary or deflationary.
Green transition's complex price tag
This model comparison underscores the profound complexity central banks face in navigating the green transition's macroeconomic impacts.
It reveals that the inflationary or deflationary outcome hinges critically on policy responses and how expectations of potential output evolve.
For policymakers, this means a heightened need for sophisticated, multi-sector analytical tools to manage the inherent trade-offs effectively.