From carbon policy to consumer prices: The economic impact of carbon caps in the Euro Area

Abstract

This study quantifies the impact of European Union Emissions Trading System (EU ETS) on inflation and key macroeconomic variables in the Euro Area (EA). Using a structural vector autoregression (SVAR) model, the analysis reveals that stricter climate policies significantly affect industrial production, unemployment, and inflation in transportation, utilities, and food sectors. Furthermore, the post-2020 regulatory adjustments in emissions caps and allowances have contributed to recent consumer price increases, an effect amplified by the COVID-19 pandemic and geopolitical tensions. The findings suggest the European Commission underestimated the macroeconomic consequences of EU ETS Phase 4. This highlights the need for a more flexible climate policy approach that balances environmental goals with macroeconomic stability.