Energy Transition, Price-Quantity Market Interactions and Inflation – A Model-guided Study and CIVAR Empirics for the US Explaining Fossilflation and Greenflation

Much Keynesian-oriented research on energy policies has studied the effects of quantity shocks on sector expansions and contraction. The New Keynesian literature has considered the energy transition and their effects on relative prices due to fossil fuel and renewable energy shocks resulting from carbon tax and subsidies. We consider sectoral dynamic interactions of quantities and prices in markets after shocks. The issue here is then to what extent do prices and quantities change when there are quantity shocks. On the other hand, how sizable are the price and quantity effects when there are price shocks. New Keynesian literature refers to the monopolistic competition theory and the Lerner measure, capturing demand elasticity, and is relying on expected future marginal costs and markups studying equilibrium relative price change. Instead of using this proposition, or partially assuming or estimating elasticities, we undertake here model guided econometric VAR and CIVAR estimations, to understand the size of the interaction effects of quantity and price shocks in markets not necessarily in equilibrium, but when market variables have moved below or above some trends. As to the energy transition we show that in higher carbon intensity sectors the prices and quantities move differently as compared to less carbon intensive sectors. As we demonstrate the relative quantity and price changes show sectoral dependency – the price and quantity shock responses are dependent on the carbon intensity of the sectors.