Global | Unraveling the impact of a carbon price shock on macroeconomic variables

Summary

This study analyzes the macroeconomic effects of carbon price shocks (EU-ETS) via a SVAR with Narrative Sign Restrictions. Facilitating identification and isolating shocks from demand factors, results indicate a stronger economic impact than previous carbon policy studies, but milder than recent works focused on the EU-ETS.

Key points

• Key points:
• Effective Emissions Reduction: Carbon pricing under the EU-ETS generates persistent reductions in greenhouse gas emissions, confirming its effectiveness. However, these gains come with transitional costs such as a negative impact in activity and temporary inflation.
• Methodological Innovation: Incorporating Narrative Sign Restrictions in SVAR models facilitates carbon shock analysis by anchoring the analysis in key regulatory events. This approach effectively isolates carbon price disturbances from demand-driven shocks, aligning outcomes with observed macroeconomic and GHG emission trends.
• Economic Trade-offs: Carbon price shocks significantly reduce industrial production without triggering a total economic collapse. The estimated GHG emissions-IPI elasticity is significant but remains below one (approximately 0.6), contrasting with recent studies that point towards a higher responsiveness (e.g., Kanzig 2023–24).
• Decarbonization Feasibility: Although the economic costs are considerable, they could be manageable if breakthrough and unprecedented innovations in the coming years substantially reduce the estimated emissions-activity elasticity. Achieving climate goals without major economic disruption will require technological progress to outpace historical trends.

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