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Climate inflation: that’s how high prices would have skyrocketed considering CO2 emissions

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See i prices to consumption in the last 50 years had included the cost of our emissions of CO2, we should have seen a rise in the prices of 50%. The estimate on the so-called climate inflation was quantified by Algebris’ analysis. Human beings have lived beyond their (planetary) means. Each year, the Earth Overrun Day indicates the date on which our demand for ecological resources exceeds the biocapacity of the Earth, that is, how much the planet can regenerate each year. In 2021, that date fell on July 29 – indicating that our ecological footprint in the first seven months was sufficient to exhaust our entire annual regeneration capacity. Humans would need nearly two planets to meet 2021’s resource demand. The last year we consumed less than the earth could sustain was 1970. Since then, humanity has been running into a growing deficit. If we wanted to reduce the debt accumulated with our planet, it would take 14.5 years without pollution. Economic theory tells us that persistent deficits should cause inflation, but our planetary deficit has not been reflected in higher prices. We haven’t had to pay for it yet, but we’ll have to start doing it soon.

In debt to the planet

Intuitively, there is a limited amount of resources that we can consume without eroding the biocapacità land. Beyond that level, consumers would have to pay, as is the case anywhere else market. Global policymakers and corporations are already taking steps in this direction, through emissions taxes and net zero pollution policies. The question therefore is: how much will CO2 weigh on consumer spending, while this process of internalising pollution continues? We estimated that consumers would have had to bear a significant cost over the past 50 years – in the order of 1% per year on average of household per capita consumption in the EU – if they had had to pay for the growing CO2 deficit. Had this effect been incorporated into prices, the EU consumer price index (CPI) would have been 50% approximately higher than estimated.

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The risks of the climate

The framework of Planetary Boundaries (PB) offers a simple analysis method, defining a global ‘safe operating space’ for human activity, outside of which the risk of a change environmental irreversible grows. In the case of CO2, the planetary boundary is a limited budget of the total tolerable greenhouse gas (GHG) emissions. The remaining budget is roughly 550Gt CO2 to stay below 1.5 ° C of global warming, or 1000 Gt CO2 to stay below 2 ° C. For the EU, the budget is 40 – 70 Gt CO2. In 1970 – the last year the carbon budget broke even – our GHG emissions were 14 Gt CO2, the same level we should reach by 2050 to keep the temperature increase within 1.8 ° C. If each emission in excess of this sustainable level had been priced at 60 EUR / tCO2, assuming a complete pass-through at product pricesiii, the annual cost to pay for the growing emissions deficit would have been about 0.4% of consumption per capita. of households in the OECD average. For the average EU consumer, this cost would have been more than double (~ 1%). In the absence of changes in people’s behavior (therefore assuming that the pricing of emissions had not reduced consumption) the cost would have increased by 0.7% for OECD average consumption and by 1.7% for the average EU consumer. The cost to pay for emissions would therefore have grown faster than consumer spending, which has roughly doubled over the past 50 years. If we assume a higher price for the most polluting products, rather than a uniform price of EUR 60, the proportionate effect of consumer spending would be greater.

Scarce resources

In the lasts 50 years we consumed without considering the cost of exploiting the resources scarce. The UN expects the extraction of scarce resources to grow 190 billion of tons by 2060. To stay in one sustainable scenario, this quantity must be reduced by 25%. With a price elasticity of around 0.35v, achieving such a decline would require 70-75% higher prices in the long run. This would imply that prices for the average European consumer are expected to grow by 0.9% per year. Another hidden cost of our biocapacity deficit is the growing physical risk, resulting from more frequent extreme weather and natural disasters (such as the recent floods in Germany or the fires in California). Tax risk can impact prices through higher insurance premiums, while disruptions in value chains may become more frequent due to damage to physical capital. As we have seen in the case of COVID-19, these supply-side shocks tend to be inflationary. Looking ahead, we may have to face more and more and more serious ones. Overall, the ECB’s estimates indicate an impact of increasing physical risk on inflation in a range of 0.05% to 0.5% per annum, depending on how the transition will be managed, whether orderly or not.

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Policies and the inflation effect

Policies are being introduced forinternalizationand of externalities that were not priced up to now, setting up reduction plans for emissions and ambitious goals of zero net pollution. In the short term, emissions will therefore become more expensive. To ensure the achievement of the GHG emissions target for 2030, the European Commission intends to accelerate the gradual reduction of the amount of emissions allowed in its Emission Trading System (ETS). Assuming an emissions price between EUR 30 and 60 / tCO2, paying for the excess emissions compatible with 1.5 ° C warming would add an additional 0.16% -0.32% to prices in Europe. At the same time, the energy cost spikes we are seeing in 2021 could become more frequent. Renewables are volatile – as wind and droughts that interfere with hydropower output have shown recently – and natural gas and coal still make up 40% of energy sources in Europe. The demand for natural gas will have to grow as more emerging countries begin the transition from coal and, with nuclear power considered taboo in many countries, this could lead to more frequent spikes in energy prices. While we have not attempted to estimate the price volatility associated with the transition, it is worth noting that it will take some time to change the energy mix and we should expect an increasing impact of supply and demand fluctuations on energy price changes relative to the past.

The inflation target

the central banks they have struggled for years to achieve theirs inflation target of 2%. Ours results suggest that you include in the basket of prices to consumption the cost of emissions he would have done half the work himself. Emissions inflation would have outweighed the contribution of energy inflation in Europe over the past 20 years, given that the difference between total and core inflation averaged 0.75%. As the global economy moves into a new phase of higher inflation, policies to gradually internalize externalities that we have not paid so far imply a new cause of inflation that central banks must recognize: climate inflation. Milton Friedman famously said that inflation is a monetary phenomenon. The green transition could show us that inflation is becoming a physical phenomenon that will cause a monetary one.

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