Emission impossible: Balancing Environmental Concerns and Inflation

René Aïd (), Maria Arduca (), Sara Biagini () and Luca Taschini ()
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René Aïd: LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
Maria Arduca: LUISS - Libera Università Internazionale degli Studi Sociali Guido Carli [Roma]
Sara Biagini: LUISS - Libera Università Internazionale degli Studi Sociali Guido Carli [Roma]
Luca Taschini: The University of Edinburgh

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Abstract: We provide a theoretical framework to examine how carbon pricing policies influence inflation and to estimate the policy-driven impact on goods prices from achieving net-zero emissions. Firms control emissions by adjusting production, abating, or purchasing permits, and these strategies determine emissions reductions that affect the consumer price index. We first examine an emissions-regulated economy, solving the market equilibrium under any dynamic allocation of allowances set by the regulator. Next, we analyze a regulator balancing emission reduction and inflation targets, identifying the optimal allocation when accounting for both environmental and inflationary concerns. By adjusting penalties for deviations from these targets, we demonstrate how regulatory priorities shape equilibrium outcomes. Under reasonable model parameterisation, even when considerable emphasis is placed on maintaining inflation at acceptable levels or grant lower priority to emissions reduction targets, the costs associated with emission deviations still exceed any savings from marginally lower inflation. Emission reduction goals should remain the primary focus for policymakers.

Keywords: Allowance dynamic allocation; Cap-and-trade; Carbon pricing; Inflation; stochastic dynamic optimization; Market equilibrium JEL subject classifications: C61; General Economics (econ.GN); FOS: Economics and business (search for similar items in EconPapers)
Date: 2025-03-28
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