Conference Agenda

How should monetary policy respond to climate policy shocks? We develop an Environmental New-Keynesian model to study the macroeconomic effects of carbon pricing and green subsidy shocks and the optimal monetary policy responses. Given the imperfect complementarity between energy and other production inputs or consumption goods, optimal monetary policy should aim to dampen real output fluctuations while ensuring long-term price stability. This implies that the policy rate should be temporarily reduced in response to a carbon price hike and raised in response to a green subsidy increase. Our findings show that dual mandate Taylor rules outperform those targeting only inflation. Additionally, rules focusing on core inflation result in lower welfare costs compared to those targeting headline inflation. However, this difference is reduced in response to a green subsidy shock or when the short-term dependence of the economy on fossil fuels and energy increases.

Climate change and geopolitical tensions render supply shocks more likely, which can trigger inflation (“shockflation”). Additionally, the EU’s reliance upon an emissions trading system as its chief climate mitigation policy can give rise to inflation (“carbonflation”). Through simulations using an input-output price model for Germany, we show that the same systemically significant sectors – those essential for human livelihoods, production and commerce – present points of vulnerability for shockflation and also carbonflation, if carbon markets are the only policy tool deployed to cut emissions. A total of up to 91.3 percent of potential carbonflation can be attributed to just six systemically significant sectors. Our findings remain robust under varying assumptions regarding substitution and passthrough effects. The challenge for policymakers is to design policies that combine transformation with stabilization. Enhancing resilience, dampening price volatility and designing green industrial policies for these key sectors can reduce the macroeconomic risks of both carbonflation and shockflation.

Flaring is the practice of burning associated gases obtained while producing oil. Following the World Bank Zero Routine Flaring Initiative, many countries have proposed bans on routine flaring. We demonstrate that routine flaring is fundamentally caused by insufficient demand for natural gas, a low-valued by-product recovered while extracting the higher-valued main product, oil. The economic consequences of reducing flaring, therefore, are primary observed in oil markets rather than natural gas markets. To demonstrate this, we build a conceptual model that matches price behavior in both oil and gas markets and test it. Theoretical and empirical results show that both gas and oil prices affect flaring and venting, but in \emph{opposite} directions. Higher gas prices reduce releases, whereas higher oil prices increase them. We then test the policy implication of the insufficient demand mechanism and estimate the costs of regulating flaring, using a policy experiment in the Canadian province of Alberta. We find that emission reductions come with oil output losses. The loss in the main product, oil, illustrates why firms may strongly oppose to zero routine flaring restrictions. We provide further evidence that most output losses occurred at sites with legacy capital.

Energy price shocks are known to be influential in shaping aggregate fluctuations. This is due to the energy sectors’ position as production network hubs: they are key input-suppliers to many other central sectors, which renders their ability to propagate shocks out of proportion to their GDP share. I quantify the importance of the energy sectors in macroeconomic shock propagation and amplification across sectors for 9 small, open European economies using international sector-level input-output data. While existing research on sector-specific shock propagation relies on closed-economy models, I demonstrate that incorporating an open-economy framework—accounting for substitution between imported and domestic energy commodities as well as pre-shock price differences—significantly alters impact estimates. This approach mitigates the estimated negative GDP effects of an energy import price shock, though the precise magnitude of the effect depends on the elasticity of substitution.