Macroeconomic effects of carbon prices – a cross-country perspective

In the fight against climate change, the EU has set ambitious targets for its member states to decarbonize their economies by 2050. While carbon prices are among the proposed policy instruments to reduce greenhouse gas emissions, the carbon taxes currently in place are nowhere near the levels that would reduce emissions sufficiently. We use a globally integrated forecast model to simulate the introduction of carbon prices that reduce emissions to the EU’s targets, assuming that carbon prices are the only effective climate policy, while in reality, a bundle of policy measures will be necessary to reach these targets. Then we assess the effects of these prices on GDP and inflation as well as the potential tax revenues generated by these prices. The results highlight the multifaceted impact of high carbon prices within the euro area: We find that we would need a sharply increasing average carbon price – from the actual price of EUR 43/t CO2 in 2024 to EUR 668/t by 2030 – to achieve the planned reduction for the euro area aggregate, although the required price changes vary across member states. The macroeconomic effects seem manageable at the euro area level, with a cumulative GDP loss of –2.2% and a cumulative increase in the consumer price index (CPI) of 6.4 percentage points from 2024 to 2030. However, for countries with a low share of renewable energy capacities and a strong reliance on fossil fuels in production, combined with low incomes, the impact on GDP and inflation may be double the size of the euro area average. For countries that have already undertaken ambitious investments in the green transition the effect on GDP is only half of the euro area average and significantly lower for consumer prices. We show that carbon pricing may be a very powerful tool to reduce emissions. However, the heterogeneity of economic impacts across member states highlights the need for coordinated support and targeted investment in renewable energy capacities, which could be partially funded by the tax revenues obtained from carbon pricing.