Effects of Monetary Policy Rates on Energy Technologies: Implications for the European Green Transition

A swift transition to renewable energy sources in the European Union is necessary for mitigating climate change. However, in a period of higher ECB policy rates meant to combat inflation, it is unclear how monetary policy impacts renewable energy installation. Prior research shows heterogeneous effects of policy rates on sectors with varying industrial characteristics, meaning that renewable technologies may be hit disproportionately by monetary contractions due to their investment requirements, life-cycle stage, and/or dependence on external finance. This paper uses fixed effects panel analysis of 27 European countries to look at the interactions between installed capacity of 10 utility-scale energy technologies, their characteristics, and monetary policy. Over the period of 2001-2021, fossil fuel, hydropower and nuclear technologies were positively affected by monetary contractions, while a 25 basis point rise in policy rates was associated with an 8% decrease in the new installed capacity of wind offshore plants, and a 26.5% decrease for solar PV. Significant interaction effects using measures of investment intensity and external finance dependence for energy technologies, yield evidence in favour of the interest rate and balance sheet channels of monetary policy transmission. To address endogeneity concerns, we use a two-stage least squares (2SLS) approach in an LCOE specification for the interest rate channel in the energy sector which confirms these findings. Our results suggest the existence of an unintended bias in contractionary monetary operations and central banks should consider flanking policies (such as preferred interest rates) to offset the disadvantage for renewables.