There are very few things that we can all agree on in life, but at the moment, it would be hard to disagree that inflation is a problem.
In July, it hit 8.5% annually in the United States and that’s a big deal. Inflation makes everyone poorer.
But is the commitment to reducing carbon emissions to zero by 2040, otherwise known as “net zero”, having an impact on inflation and if so, what can be done about it?
Well, as you might expect, there’s a ton of disagreement about whether net zero has any impact on inflation and if it does, exactly how much impact it has.
The Case Against Net Zero Driving Inflation
Patrick Thomas of ESG Clarity argues that net zero will not be inflationary, at least, not in the long term.
He says that there are three strong reasons why reducing carbon emissions won’t drive inflation long-term:
- The cost of green tech is falling all the time. He points to the fact that, for example, electric vehicle batteries have seen a 90% price drop in the last 10 years or so. He also notes that as fossil fuels become more scarce that the price of these fuels must rise because they will become more expensive to extract. (Critics will note that this is the “peak oil” theory and there’s little evidence that this point is particularly close to us, today).
- Higher prices must be matched with reduced purchasing power. His argument here is that some things may get cheaper as energy gets more expensive. He offers the idea that, for example, net zero might lead to higher energy prices, which, in turn, would reduce the demand for car ownership leading to a fall in car prices which would offset the increase in energy prices.
- Consumer choice will lead to more eco-friendly, cheaper choices in other areas reducing inflation. Finally, he sees a move to a “circular economy” driven by eco-friendly minded consumers opting for things like secondhand, rather than new, clothing driving prices down in other areas to offset the inflationary pressure of energy costs.
The Case In Favor Of Net Zero Causing Inflation
There are other voices out there such as Irene Lauro of Schroders, Philip Barrett of the International Monetary Fund (IMF), and Justin Chaloner of Capital Economics that disagree with Patrick’s assessment.
They say that the transition to net-zero must have a modest inflationary impact but that central banks may find this challenging to manage if they are dealing with other inflationary drivers at the same time. (This might include the impact of the Ukraine War, pandemic lockdowns, etc.)
The IMF’s data shows that rising prices of energy are, conclusively, driving inflation in the current moment though nobody at the IMF is disputing the need for reducing carbon emissions if we want to get climate change under control.
Irene Lauro’s analysis shows that inflation is not only real but a necessary consequence of net zero policies and that we will need to endure a period of short-term pain to achieve the carbon emissions target. She also notes that if inflation gets out of control, central banks may look to abandon net-zero commitments in order to preserve price stability.
She notes, however, that France will see little inflationary pressure from the transition as much of its economy is already running on “green energy” and it has less work to do than most developed nations.
Our View On Net Zero And Inflation
We think it’s impossible to ignore the negative impact of net zero on inflation and that the weight of current analysis favors this interpretation of the data.
However, we believe that achieving net zero is a necessity for life on Earth and that we may all need to experience some pain to get there.
What is needed though is for governments to take action to push down inflation in other areas as rapidly as possible to minimize this impact on people, particularly the poorest in our societies and to manage the roughest part of this transformation with finesse so that people can quickly come to feel better about the transition to a zero carbon economy.