Climate change will keep inflation stubbornly high and result in low investment returns for an extended period, Nicolai Tangen, the head of Norway’s $1.3 trillion oil fund, is warning.
Tangen told the Financial Times on April 25 that “inflation is going to be tough to get down,” alluding to a multitude of factors, such as rising labor costs and higher food prices. These, he noted, could keep inflation elevated for years.
A part of the “mosaic,” according to Tangen, is that the exorbitant investments being made in the green energy transition and the deglobalization initiative currently occurring also will add to inflation pressures.
The idea of “greenflation”—that is, the transition to green energy to achieve climate change goals that will contribute to inflation—has been a common discussion in economic circles.
But is it largely an unfounded concern, or is it an accurate expectation?
The Threat of Greenflation
Isabel Schnabel, a member of the executive board of the European Central Bank (ECB), told a panel in March 2022 that the transition to a green economy will come with a cost: higher prices. But the German economist conceded that it’s necessary to shift to a net-zero economy.
However, she explained that greenflation would lead to fiscal and monetary consequences, forcing policymakers to help families grappling with rising energy prices.
“As more and more industries switch to low-emission technologies, greenflation can be expected to exert upward pressure on prices of a broad range of products during the transition period,” Schnabel stated.
“The transition to this new steady state will not come for free,” she said, adding that the price of this “new age of energy inflation … is worth paying.”
Schnabel isn’t the only one warning about greenflation.
TD Bank published a research note on March 22 explaining that the global economy should “expect moderately higher inflation as a result of the transition to net-zero emissions.” The paper noted that there would be four factors that would trigger green inflation: greater global capital investment, higher demand for commodities (e.g., carbonate, cobalt, nickel), green premiums, and carbon pricing.
“While inherently imprecise, we estimate these factors will increase trend inflation by 25–50 basis points (bps) over the next decade,” the report stated. “The confluence of greenflation plus the reflationary effect of deglobalization is likely to more than counterbalance the deflationary impact of tech. Consequently, inflation and nominal interest rates will probably be higher and more volatile, especially relative to the levels of the last two decades.”
Many market experts agree that strengthening demand for the so-called green metals would support higher prices. However, industrial metals have been mixed so far this year. Nickel prices are trading at decade highs, cobalt has slumped nearly 33 percent year to date, and lithium carbonate has tumbled to an 18-month low.
“Greenflation is inevitable,” say Deutsche Bank economist Eric Heymann and thematic research analyst Luke Templeman.
The bank’s report noted that it needs to be clarified how much of the enormous amount of money needed to achieve the worldwide net-zero goal is inflationary. But climate policy issues, rising commodity prices, environmental, social, and governance (ESG) compliances, weather-related events, and interest rates could also exacerbate greenflation concerns.
Economists at the Federal Reserve Bank of New York disagree that central banks need to admit defeat and accept persistently higher inflation levels while grappling with climate change and instituting a low-carbon marketplace. Instead, the New York Fed researchers believe a climate policy of subsidizing green energy rather than taxing fossil fuels can lead to a disinflation trend.
“In such a world, therefore, climate policies would pose no particular problem for inflation-targeting central banks,” the regional central bank wrote.
Still, there are costs to closing coal and nuclear power plants that generate reliable and affordable energy, says Isaac Orr, a policy fellow at the Center of the American Experiment.
If households are still experiencing higher utility bills, many green energy policies might come under scrutiny, he noted.
“The energy policies pushed by liberal wind and solar advocates are about to garner the scrutiny they always deserved,” he stated. “Rising costs will give the public the permission it needs to reevaluate the received wisdom that wind and solar will bring down prices, and when people learn that they have been deceived, they will be very unhappy.”
Will the Inflation Reduction Act Curb Inflation?
The Inflation Reduction Act has been marketed as President Joe Biden’s landmark legislation to combat inflation by accelerating the push for green energy. But estimates since last summer suggest that it might not influence inflation levels as much as proponents had intended.
The Penn Wharton Budget Model found that “the impact on inflation is statistically indistinguishable from zero.” The Congressional Budget Office also estimated that the bill would have little effect on inflation.
A recent paper published by the Brookings Institution, however, estimated that the Inflation Reduction Act will trim inflation by as much as 6 basis points in 2030 and as high as 30 basis points in 2050.
Economists charge that there will be an inflationary component, at least in the short term, by facilitating increased demand for a broad array of renewable technologies. But whether this is a price worth paying, as many policymakers assert, will be left up to households everywhere.
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