The Year Ahead 2022: Why ‘greenflation’ could confront policymakers and society with new challenges

22 November 2021

Alvaro VivancoHead of Emerging Markets Strategy and Head of ESG Macro Desk Strategy.

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Giovanni ZanniChief Euro area Economist

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As climate and social sustainability issues move to the top of the agenda, one of the biggest concerns is that greening the economy could result in higher inflation or ‘greenflation’. In the Year Ahead 2022, we consider some of the key questions about the link between going green and inflation, and potential implications for central banks and for society.

Listen to our podcast on ‘greenflation’ and the potential impact of a more sustainable society on prices: Apple Podcasts, Spotify, YouTube.

Will producers be able to pass on higher prices for sustainable products?

Rising demand for sustainable goods has direct consequences for producers’ pricing decisions as sustainable products tend to be more expensive. Exactly how much more expensive is difficult to measure, but there’s clear anecdotal evidence in sectors like the fashion industry, where firms often report higher operating costs resulting from the implementation of sustainability measures. Similar patterns have been seen in the cosmetics, pharmaceutical, construction, housing, and food sectors.

Is the general public willing to pay more for sustainable products? It would seem so. The European Commission has reported that two-thirds of consumers would be willing to buy more sustainable products even if they were more expensive. Some studies have even suggested that up to 25% of those polled would be willing to pay over 10% more for greener products.

Consumers are willing to pay more for greener products, surveys suggest

Sources: YouGov Survey, April 2021. Survey question: Do you agree or disagree with the statement: “I don’t mind paying more of products that are good for the environment”

Broader cross-national surveys show that between 53–60% of consumers in most developed countries (Japan being the clear exception) are willing to bear higher costs for products that are seen as more environmentally friendly. Will consumers incur the higher cost when it comes to the actual purchase decision? If they do, it has clear implications for inflation.

Are carbon taxes inflationary?

Another factor to consider is whether long-term policy measures such as carbon taxes could push prices upwards. This is an important question as many countries have already implemented such schemes – there are currently 64 in place – and many others are looking to expand them or put them in place.

There have been few analyses of their implications for inflation. The most detailed study found that carbon taxes did not appear to have inflationary effects, and could even have a disinflationary impact as other prices tend to fall due to the decrease in income that they result in. For instance, a study found that real household incomes in Canadian provinces where a carbon tax had been introduced fell materially following the adoption of the tax, when compared with the rest of the country.

This doesn’t rule out negative short-term effects on inflation. Most studies anticipate some near-term inflationary effects during the transition to a zero-carbon economy. For example, the implementation of climate-related measures in Germany earlier in 2021 resulted in energy price inflation.

Will the green transition result in commodity price inflation?

Commodity prices have surged recently, and some have argued that greening is partly responsible. There are both supply and demand levers at play: carbon energy production might be becoming more expensive as markets shy away from it, while metals that are required for the production and storage of green energy are subject to increasing demand.

Our own analysis casts some doubt on this. We found that the most green-intensive minerals, such as silver and aluminium, have actually underperformed over the past 18 months, while some of the sharpest price increases are seen for minerals in relatively low demand from greener technologies.

This doesn’t necessarily mean that higher demand for cleaner energy won’t become a driver of commodity prices over the long term. For some minerals, such as graphite, lithium and cobalt, additional demand from emerging technologies represents a challenge to current production levels. Shifting policy on oil might have contributed more directly to its recent price rises. Indeed, we believe private investor demand for investment in clean energy paired with public sector pressure on energy production is likely to be a theme that overhangs global energy markets over the coming years, affecting consumer demand and access to capital.

How much can technology help to reduce costs?

The declining cost of greener technology is at the core of the inflation argument and is likely to ultimately determine the net impact on prices over the long term. The economics behind sustainable production and storage are encouraging. According to Bloomberg, the global levelized cost of electricity (LCOE) for renewables has fallen sharply in recent years, even accounting for the recent spike in the prices of commodities used in alternative energy production.

Compared with an average LCOE of $70 / MWh for a gas-fired power plant and $62 / MWh for coal:

  • Onshore wind has a global estimated LCOE of $41 / MWh, down from $112 / MWh in 2009.
  • The equivalent LCOE for offshore wind is $82 / MWh, almost 60% lower than in 2009.
  • The global LCOE for fixed-axis photovoltaic is $48 / MWh, down from around $370 / MWh in 2009.
  • The global LCOE for battery storage is $138 / MWh, down from $500 / MWh in 2016.

Two trends are at work here. The first is that renewable energy is becoming cheaper at a much faster rate than traditional power generation. The second is that alongside a huge rise in installed capacity, most renewables are now cheaper in absolute terms than their conventional peers. Both trends point towards disinflation.

How much do central banks have to worry about ‘greenflation’?

Initially at least, inflationary pressures and downward pressures on economic activity seem likely during the transition towards a greener economy. However, some of these consequences can be mitigated through public policy over time – especially if large investments in green technology end up boosting economic growth and eventually offer some price relief.

Some estimates suggest net zero could result in higher near-term inflation

Sources: Network for Greening the Financial System
Sources: Network for Greening the Financial System

New energy policies in countries like Germany have added to pressures resulting from the rebound in demand and severe shortages in many sectors. ESG considerations have undoubtedly contributed to policy uncertainty for central banks, both in the G10 and emerging markets. However, the steady fall in energy prices from renewable technology reduces the likelihood of them becoming intractable issues for policymakers – even over the medium term.

Could we see a backlash from voters?

The transition to net zero brings other unique risks: those benefitting from green policies are widespread, while those opposing them tend to be concentrated yet much more motivated. In that sense, the potential for a backlash among electorates deserves careful consideration.

There are several arguments that are currently being used to oppose more sustainable policies, from job losses in carbon-intensive industries, to the potential for broadly higher costs for consumers. Most studies on carbon taxes have found an insignificant effect on output levels, but the argument that some measures are too expensive has been successful in shaping political opinions.

Ultimately, tackling climate change is a global long-term pursuit, but politicians are elected on a local short-term basis. In the years to come, coordinated global action will help to provide the overall direction, but careful policy design that accounts for local political constraints will be required.

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