Network for Greening the Financial System publishes model comparison on monetary policy implications of carbon-intensive energy price shocks

The Network for Greening the Financial System released an occasional paper comparing six multisector environmental monetary DSGE models to assess how changes in carbon-intensive energy prices transmit to inflation, output and interest rates across jurisdictions, with a focus on the monetary policy challenges posed by temporary versus permanent energy price increases. For a temporary shock, the aligned scenario models a 25% rise in the price of carbon-intensive energy for four quarters that then decays. Across models, the shock is inflationary and contractionary, with the euro area showing an average peak inflation response of around 2 percentage points and an average peak output decline of around 0.3%, alongside policy rate increases that typically peak around 1 percentage point. Results also indicate cross-country differences, including greater exposure in the euro area than the United States in some model implementations, while simulations for Chile show inflation rising by around 4 percentage points and output falling by around 1.2%. Comparing headline inflation targeting, core inflation targeting and average inflation targeting (over eight quarters), the paper finds broadly similar inflation and output dynamics across rules but meaningfully different interest rate paths, with headline targeting requiring a faster and more forceful tightening and average inflation targeting producing the strongest real contractions. For a permanent shock, the exercise phases in a 25% increase in the carbon-intensive energy price over 10 years and keeps it at that level thereafter. Real activity falls persistently across models, with GDP and consumption declines that are permanent and average close to -1% after 10 years, while the inflation outcome depends on model assumptions and, in particular, how the interest rate rule incorporates a transition to a lower level of long-run output. Targeting output relative to a slowly adjusting trend tends to generate an inflationary response supported by more accommodative real rates, whereas fully and immediately adjusting the output target to the new lower long-run level can yield short-to-medium-term deflation. The paper also reports that, in the permanent scenario, rules targeting core rather than consumer price inflation can produce larger inflationary effects on average, alongside a tighter policy stance, because the rule does not react to the direct energy-price impact.