The European Central Bank published a working paper comparing several multi-sector New Keynesian DSGE models to assess how changes in carbon-intensive energy prices propagate to inflation, output and monetary policy trade-offs in the euro area and the United States. The paper finds that both temporary and permanent energy price increases generate inflationary pressures, while permanent shifts also lower activity persistently, with inflation outcomes sensitive to model assumptions and the monetary policy response. The comparison benchmarks six institutional models (BIS-MS, SEEM, EMuSe, NAWM-E, E-QUEST and C-EAGLE) against aligned scenarios. In a temporary shock calibrated as a 25% rise in carbon-intensive energy prices over four quarters (then decaying with persistence 0.5), euro area inflation rises sharply on impact (around 2 percentage points on average, with cross-model variation) and output contracts (around 0.3% on average), prompting policy-rate tightening that gradually unwinds over roughly two years. Alternative interest-rate rules targeting headline inflation, core inflation or an 8-quarter average deliver broadly similar inflation and output paths but require markedly different interest-rate adjustments. For a permanent scenario in which carbon-intensive energy prices rise by 25% over 10 years and remain at that level, GDP and consumption fall persistently across models, with average long-run output losses around 1%. Whether the shock is inflationary or deflationary depends critically on how the central bank’s reaction function treats the implied decline in potential output: accommodating against a slowly adjusting output trend can sustain inflation pressures, while immediately internalising the lower long-run level of output can lead to deflation dominating in the short to medium term. Alternative expectation-formation assumptions mainly alter the timing of real adjustments rather than the overall inflation result.
European Central Bank 2026-02-24
European Central Bank working paper compares multi-sector models and links carbon-intensive energy price rises to inflation and around 1 percent long-run GDP loss
The European Central Bank's working paper examines how carbon-intensive energy price changes impact inflation, output, and monetary policy in the euro area and the U.S. using New Keynesian DSGE models. Temporary and permanent price increases create inflationary pressures, with permanent shifts causing persistent activity declines. The impact depends on the central bank's response to potential output changes, with interest-rate rules and expectation-formation assumptions affecting economic adjustments' timing and magnitude.