A drawn-out restart
We believe the economic restart provides a glimpse of what is to come. The transition to net-zero will be like a restart drawn out over decades, bringing with it new supply constraints that push up inflation – through both broad-based and sectoral channels.
The transition is fundamentally about including the costs of climate damages in economic decisions. These costs can be reflected in different ways: carbon taxes, regulations or just consumers choosing to pay more to avoid climate damages. Regardless of how the cost is internalized, we see a broad-based impact on inflation: energy costs are likely to increase, driving up producer and consumer prices. How that translates into inflation depends on the timeframe over which those increases occur. A smooth, even transition would spread out the impact. If the shift happens faster – condensing prices rises into a shorter timeframe – the impact on inflation would be more material.
In addition, the restart shows how another often overlooked channel will operate in the transition. Supply constraints will be caused by reallocation across sectors, in this case to accommodate shifting energy demands. In their World Economic Outlook,
the IMF suggests that over 2% of global employment will ultimately need to change sector to meet these demands – see the chart. If demand shifts faster than resources are reallocated, the mismatch could push overall inflation higher – like a stretched-out version of the economic restart.
The most effective way to contain inflation during the transition, in our view, is to ensure the transition is gradual and orderly, so that supply can keep pace with shifting demand across sectors and higher energy costs can be absorbed over time. A transition left too late may keep inflation down in the short term but risks a much greater overall impact later on.
Would no transition at all be a better strategy for containing inflation? Not in our view: while the transition – even an orderly one – is likely to bring higher inflation, we believe it will still deliver a better outcome in terms of both the level and volatility of inflation than a failure to act. No climate action would mean rising global temperatures, more frequent severe weather events and greater economic damage: in previous work, we estimated that no climate action would result in a cumulative loss in economic output of nearly 25% over the next 20 years. We would expect more frequent and sharp spikes in energy, food and other prices due to severe supply constraints – akin to a pandemic on repeat.
Labor shifts needed for transition
Net employment change, 2020 vs. 2052