Although there is considerable uncertainty over the extent to which the climate transition will affect inflation, there are scenarios in which the impact will either be limited or easy for monetary policy to address, according to new research from the Swedish central bank.
Policymakers have been warning about the threat of so-called greenflation, whereby costs rise as the flow of fossil energy is reduced before there is a corresponding growth in supply from renewable sources. This may be exacerbated by an increase in the price of materials required in the creation of green technologies.
In an economic commentary, Mikael Apel writes that this may not be as significant an issue as some have feared.
“One possibility is that investments in new technologies are made so soon and are so large that their effect on demand in the economy not only dampens but also dominates the negative supply effect that arises when CO2-intensive technologies are phased out,” he says.
His comments echo those made by analysts at the clean energy think tank RMI, who have stated that although supply chain issues and material costs have pushed up the price of renewables in the past year, there is nothing to suggest the long-term structural drivers of falling costs have weakened.
They cite the manufacture of solar panels by Chinese companies as an example of how short-term hikes in material costs can be overcome.
“The limited supply of polysilicon (a high purity form of silicon key to manufacturing solar panels) has been a factor in the recent increase in solar panel prices; but Chinese companies are planning to increase polysilicon production capacity enough to make 900GW of solar panels annually by 2023, more than three times the expected demand this year,” the analysts say.
Apel also argues that even if the climate transition were to lead to higher inflationary pressures than in recent years, this would not necessarily be a problem. Over the past decade, central banks have been grappling with deflationary pressures fuelled in part by digitisation and globalisation, and have been unable to respond effectively because interest rates are already near the lower bound.
If the underlying pressure on inflation were instead upwards in the future, there is no corresponding restriction on using the interest rate tool to maintain the inflation target, he concludes. “Instead, it could help to ensure that central banks’ policy rates can move more permanently away from the lower bound.”
Isabel Schnabel, a board member at the European Central Bank, said earlier this year that although monetary policy has tended to “look through” energy price shocks, a response could be necessary if inflation expectations risk becoming destabilised, or if price pressures occur alongside a boost in growth and demand.
Apel agrees, saying timing is the key factor. He says the longer inflation is allowed to remain high, the greater the risk of expectations being affected in the long term, and the greater the real economic costs will be of bringing inflation back down.
This page was last updated May 17, 2022
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