The EU’s Energy Transition and Fuel Price Shocks

This paper analyzes how achieving Europe’s medium-term greenhouse gas mitigation targets enhances energy security, defined as the cushioning of the adverse macroeconomic impact of oil and gas price shocks. It uses the IMF’s Global Macroeconomic Model of the Energy Transition, which combines a rich set of New-Keynesian features with a detailed representation of fossil fuel use, including granular modelling of the transport and heating sectors. Future oil and gas price shocks are simulated in a scenario where Europe’s mitigation policy agenda has been fully implemented (and mitigation targets are met), and in a hypothetical scenario where mitigation policy has remained constant at the current level of ambition. A comparison shows that the policy agenda substantially dampens future shock transmission. The inflationary impact of both shocks is close to 40 percent larger under constant policies than under the mitigation agenda, and for oil shocks, the output decline is about twice as large. These energy security co-benefits materialize gradually as the economy adjusts to the mitigation agenda, and are shown to depend on ETS2, the new emissions trading system covering transportation and buildings. An additional exercise proxies for merit-order electricity pricing. In these simulations, the mitigation agenda further reduces pass-through from gas price shocks to electricity prices, thereby enhancing the macroeconomic stabilizing effects.