The European Central Bank has published Working Paper No. 3032, which uses a New-Keynesian DSGE model with a disaggregated energy sector and financial intermediaries to examine how euro area energy-related fiscal measures and macroprudential policies jointly affect inflation, output and carbon emissions during an energy crisis. The paper finds that the macroeconomic effects of energy subsidies vary materially depending on whether they target firms’ energy costs or households’ energy bills, and argues that pairing subsidies with macroprudential measures aimed at banks’ dirty-energy exposures can mitigate the emissions trade-off. In an illustrative fossil-resource price shock (a temporary 50% increase with persistence of 0.85), the model generates higher CPI inflation (around 1.3 percentage points) and core inflation (around 0.6 percentage points) alongside lower GDP (around 1.2%) and lower emissions absent policy action, with financial frictions amplifying the contraction through a leverage-constrained banking sector. Subsidies to energy production reduce both CPI and core inflation and raise output, while subsidies to energy consumption reduce CPI inflation but increase core inflation and lower output; a subsidy that lowers the price of dirty energy produces intermediate macro effects but leads to the largest increase in emissions. The framework also analyses an “emissions-prudential” approach in which a tax on dirty energy assets in bank portfolios shifts credit toward clean energy and intermediate-goods investment, supporting green investment and curbing subsidy-driven emissions increases, and notes that the findings are the authors’ and do not represent ECB views.
European Central Bank 2025-02-19
European Central Bank publishes working paper on how energy subsidies and macroprudential taxes interact during fossil price shocks
The European Central Bank's Working Paper No. 3032 examines the impact of euro area energy-related fiscal measures and macroprudential policies on inflation, output, and carbon emissions during an energy crisis using a New-Keynesian DSGE model. It finds that energy subsidies' effects vary depending on whether they target firms or households and suggests combining subsidies with macroprudential measures on banks' dirty-energy exposures to mitigate emissions trade-offs. The paper also proposes an "emissions-prudential" approach, including a tax on dirty energy assets to promote green investment and reduce emissions.