Managing Inflation by Boosting Energy Transition

This Reclaim Finance report examines the three types of climate-related inflation and shows that managing this price instability requires support for a clean energy transition.

The report begins by examining the price impacts of three aspects of inflation, previously identified by European Central Bank (ECB) board member Isabel Schnabel: fossil fuel dependency (or fossilflation); physical climate impacts (climateflation); and short-term supply bottlenecks for key materials required for the green transition (greenflation).

It argues that greenflation is “largely a myth” and can be prevented completely by a planned and orderly transition. In contrast, fossilflation and climateflation are directly contributing to current price instability and will continue to do so until fossil fuel use comes to an end.

Turning to the ECB’s primary mandate of price stability, the authors suggest it has no choice but to become an active supporter of a clean energy transition. “The endogenous, global and volatile dimension of climate-related inflations make them impossible to manage if their drivers – namely greenhouse gas emissions and fossil fuel consumption – are not considered,” they say, adding that a lack of action by the ECB on climate could intensify this price instability.

The author argue that the ECB’s secondary mandate of contributing to achieving EU objectives also requires that it act to mitigate emissions, pointing out that limiting climate change stands out among other EU policies and objectives. This is due to the macroeconomic effects of climate change, the magnitude of the challenge it presents, and the clear international and European goals that have been set to address it.

The report then looks at how the ECB can fulfill its mandates by contributing to efforts to solve both the energy and climate crises, highlighting three essential measures the ECB should adopt. Fossil fuel developers should be excluded from both asset purchases and the collateral framework, and a green lending facility to support building renovation and sustainable energy should be introduced.

It also calls on the ECB to coordinate with the European Investment Bank (EIB) and the European Commission to help the EU fund clean energy and energy efficiency measures while limiting state debt. This could be done through the issuance of EIB climate or ”just transition” bonds which would be purchased by the ECB through its asset purchasing programmes. The ECB could also buy debt jointly issued by EU countries to fund their transition, with these new funds directed to existing EU programmes such as the Just Transition Mechanism and the Social Climate Fund.

“The ECB cannot keep on supporting companies at odds with the climate and energy goals of the EU, nor continue to ignore the EU’s urgent need for clean transition funding,” it concludes, quoting a warning from former Bank of England governor Mark Carney:

“Caught in the climate version of Paul Krugman’s timidity trap, we are dithering towards climate disaster – a drift that, if allowed to continue, will at best set up a future climate Minsky moment, with policies that cause abrupt and wrenching economic adjustments, strand trillions of dollars in assets, and impair financial, price and potentially geo-political stability.”