National Bank of Denmark working paper models EU ETS2 effects on consumer durables and finds strict headline inflation targeting could slow the green transition

The National Bank of Denmark published a working paper analysing how the EU’s planned extension of carbon pricing to household-related sectors could interact with monetary policy. Using a New Keynesian model with “brown” and “green” consumer durables, the paper finds the transition is likely to be modestly inflationary under a conventional policy rule, and that a strict focus on headline inflation could slow the shift towards greener durables because those purchases are particularly interest-rate sensitive. In the baseline simulation, an emissions price path rising from EUR 45 per ton to EUR 140 per ton over four years increases headline inflation by about 20 basis points during the transition period. The paper contrasts strict headline versus strict core inflation targeting and quantifies a trade-off between keeping headline inflation on target and the pace of substitution from brown to green durables. Over a two-year horizon, “looking through” emissions prices via core-inflation targeting raises the green-to-brown durable stock ratio by an additional 12 basis points relative to headline targeting, with average headline inflation 3.5 basis points higher. Over five years, the additional increase in the green-to-brown stock ratio rises to 72 basis points while the average headline inflation difference falls to 1.5 basis points. The authors also report that the trade-off persists under a fully anticipated emissions price path, and that green-durable subsidies generate little headline inflation impact in their setup. The paper reflects the authors’ views and not necessarily those of the National Bank of Denmark.