Consumer durables, monetary policy, and the green transition

As part of the green transition, the European cap-and-trade scheme for CO2 emissions will be extended to include consumer durables. We propose a New Keynesian model that features both “brown” and “green” durable goods, and show that if monetary policy follows a business-as-usual approach, the green transition will be inflationary, with headline inflation rising by up to 20 basis points. Monetary policy faces a tradeoff: strictly targeting headline inflation slows the green transition, as purchases of green durables are particularly sensitive to interest rates. We explore this tradeoff by comparing adjustment dynamics under a headline-inflation target and a core-inflation target.