European Central Bank working paper finds renewable investment limits GDP hit from a EUR 100 EU carbon price and shows Carbon Border Adjustment Mechanism reduces leakage at additional cost

The European Central Bank published a working paper modelling the macroeconomic and emissions effects of adding an extra EUR 100 per tonne of CO2 to EU carbon pricing and introducing a Carbon Border Adjustment Mechanism (CBAM), using a multi-country production-network framework with an energy block and endogenous renewable electricity investment. The simulations suggest renewable deployment materially dampens electricity price increases over the medium term, delivering larger emissions cuts with a much smaller GDP loss than models that omit the investment response. In a short-run setting without capital adjustment or renewable expansion, the model estimates EU real GDP would be 1.41% lower and CPI 0.67% higher, with CO2 emissions about 7% lower; adding CBAM reduces leakage but slightly worsens macro outcomes (EU real GDP -1.54%, CPI +0.85%) as higher costs of imported intermediate inputs offset competitiveness gains. In a medium-term setting with renewable investment, EU real GDP is estimated to be 0.41% lower under the carbon price alone (0.61% with CBAM) while emissions fall by about 24% and renewable generation rises by around 36%; under an alternative specification without renewable investment, the medium-term GDP loss rises to roughly 2.22% to 2.55% with emissions reductions around 8%. The paper links CBAM’s additional GDP drag to upstream, energy-intensive inputs (including chemicals and metals) becoming more expensive and transmitting costs through global value chains to downstream sectors such as machinery and transport equipment.