Is the Green Transition Inflationary?

We develop a multi-sector New Keynesian model to analyze the inflationary effects of climate policies. Climate policies need not be inflationary, but can generate an inflation-output tradeoff whose size depends on how flexible prices are in the “dirty” and “green” sectors relative to the rest of the economy, and on whether climate policies consist of taxes or subsidies. A quantitative version of the model calibrated to U.S. data on input-output linkages and sectoral heterogeneity in emissions and price stickiness suggests that an increase in carbon taxes would generate a sizable tradeoff: containing the impact on headline or core inflation would lead to a deep recession. But while sizeable, the tradeoff is relatively short-lived as it wanes after one year.