The Bank for International Settlements published BIS Paper No 160 on how the green transition affects inflation, output and the conduct of monetary policy. The paper argues that regulations and other forces that restrict the use of fossil fuels can shift the economy toward a more inflationary and volatile environment, and that central banks may face a sharper trade-off between keeping inflation on target and sustaining activity while the economy reallocates from “dirty” to “clean” production. Using a euro area vector autoregression, the authors find that a 10% increase in gas prices raises inflation while depressing activity and employment, and that a 1% increase in interest rates reduces inflation at the cost of weaker activity and unemployment, with a particularly large negative effect on gas prices. A separate firm-level exercise classifies US listed “green innovators” as firms with more than 25% green patents (around 50 firms on average) and finds that a one standard deviation tightening in the Chicago Fed National Financial Conditions Index is associated with larger declines in investment and especially R&D for green innovators than for other firms. Building on these facts, a New Keynesian model that treats the transition as a tightening cap on dirty output generates a non-linear Phillips curve and implies that strict inflation targeting can require larger output losses and slow the reallocation to clean production, while endogenous innovation makes monetary tightening especially damaging to clean investment and can create an intertemporal inflation trade-off by weakening future productivity. The paper concludes that subsidies or credit policies supporting clean investment can, in the model, reduce the output cost of keeping inflation on target during the transition.
Bank for International Settlements 2025-09-22
Bank for International Settlements publishes research linking fossil fuel phase-out to higher inflation volatility and weaker incentives for green investment under tight monetary policy
The Bank for International Settlements released BIS Paper No 160, examining the green transition's impact on inflation, output, and monetary policy. The study highlights that fossil fuel restrictions may lead to a more inflationary and volatile economy, complicating central banks' efforts to balance inflation targets with economic activity. It suggests subsidies or credit policies for clean investment could mitigate output costs during this transition.