“Energy Transition Faces Central Banks With Dilemma Between Stabilizing Inflation and Accepting Carbon Price Increases”

IEnergy transition is a major challenge caused by global warming. But the solution most often identified by economists, an environmental tax, raises energy bills, slows economic activity and increases inequality between households. This is what the population perceived in 2013 in the episodes of rebellion against the eco-tax and the carbon tax in 2018. Achieving carbon neutrality must be socially acceptable. Therefore, it is necessary to find an accompanying policy.

Different macroeconomic policy options are analyzed in a note from the Center for Economic Research’s Macroeconomics Observatory (Cepremap), published on 22 February. This is to support the increase in the carbon tax between 2024 and 2027, which was envisaged in 2018 before the Yellow Vests movement.

The first option, the most natural, is to redistribute the revenues from the carbon tax to households, favoring the most modest. In the second option, these revenues are invested in the thermal repair of housing, which is especially beneficial for the most modest families, whose share of heating costs in the total consumption is the highest.

But our research shows that these two supportive policies are likely to be largely insufficient in terms of economic activity and the fight against inequality, because they are at odds with the likely response of central banks.

Indeed, by supporting demand, these two policies help to fuel inflation, in addition to the already inflationary effects of the carbon tax. Thus, they oppose the goal of stabilizing inflation in the monetary policy pursued by central banks, which causes them to raise interest rates to fight inflation.

This will lead to a decrease in the effectiveness of this support policy in terms of increasing activity, and will also negatively affect the fate of the poor, who are more sensitive to the economic situation. This rise in inequality will be exacerbated by rising interest rates, which will actually benefit wealthier households, the asset owners.

Inflationary spiral

Thus, central banks will face a new dilemma during the energy transition: to uphold the mandate of inflation stability in the face of the risk of rising carbon prices.