Carbon prices and inflation in a world of shocks: Systemically significant prices and industrial policy targeting in Germany

Climate change and geopolitical tensions render supply shocks more likely, which can trigger inflation (“shockflation”). Additionally, the EU's reliance upon an emissions trading system as its chief climate mitigation policy can give rise to inflation (“carbonflation”). Through simulations using an input-output price model for Germany, we show that the same systemically significant sectors – those essential for human livelihoods, production and commerce – present points of vulnerability for shockflation and also carbonflation, if carbon markets are the only policy tool deployed to cut emissions. A total of up to 91.3 percent of potential carbonflation can be attributed to just six systemically significant sectors. Our findings remain robust under varying assumptions regarding substitution and passthrough effects. We identify three pathways to systemic significance: CPI weight, price volatility and upstreamness. This can inform decarbonization policies that pursue both a green transition of the energy system and stabilization.