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Author: Don Obrien

Politicians need to be more active when it comes to greenflation


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Three months ago Larry Fink, head of BlackRock, warned about the danger of rising prices linked to climate change. “If our solution is entirely just to get a green world, we’re going to have much higher inflation, because we do not have the technology to do all this, yet,” he said. “Are we going to be willing to accept more inflation, if inflation is to accelerate our green footprint?”

The question went largely ignored as deflation dominated the conversation in recent years. Now, however, it is becoming critically important. This month the UK is reeling from the political fallout of a surge in natural gas prices that is partly sparked by policy shifts to combat climate change (falling fossil fuel energy supplies), but also by unexpected weather shifts (wind levels have fallen, cutting supplies of energy from turbines).

Texas and California have experienced a similar squeeze due to a nasty combination of weather shocks and reforms to mitigate climate change. Meanwhile, a new surge in demand for sustainable products has collided with Covid-19 supply chain disruptions, pushing up prices for green goods in sectors ranging from pea protein used for non-meat foods to the commodities required for batteries in electric vehicles. Welcome to the world of “greenflation”.

How should policymakers respond? Three key steps are needed. First, we should all recognise that the role of the state in fighting climate change is subtly shifting. A decade ago, green activists wanted recalcitrant governments to provide the leadership for the battle to stop global warming. This is still needed, since it will be impossible to stop climate change without public policy shifts; governments must introduce policies such as carbon pricing.

But what is also notable today is the degree to which business and finance is driving climate change reforms, sometimes almost ahead of government; western coal plants are being mothballed due to investor pressure, as much as government rules.

What politicians should do now is not so much “lead” in this fight, as “follow” — in the sense of recognising that a green transition is likely to be very messy and uneven. They must step in to provide proactive solutions when market failures occur. In the UK, for example, the government should have prepared for the fact that renewable energy cannot (yet) plug the gaps created by declining fossil fuel generation. Similarly, surging prices for some commodities needed in green products suggest that western governments need to loosen regulatory rules that impede their production.

Second, governments need to create better projections of greenflation, and trade odds. This is starting to happen. The European Central Bank recently published a report which argued that policy inaction would hurt growth more than green reforms. And Yannis Stournaras, the Greek central bank governor, told a finance conference this week that central bankers are intensifying their modelling efforts.

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In the medium term greenflation need not be too dangerous, he suggested, “because we know that clean forms of energy are cheaper than fossil fuel”. However, he added, “in the short term, climatic change has a positive impact on prices through carbon pricing.”

As his Irish counterpart Gabriel Makhlouf noted, the average global carbon price today “is around three dollars a tonne”. However, the Network for Greening the Financial System, a group of central banks, recently suggested that “a carbon price of around $160/tonne would be needed by the end of the decade to incentivise a transition towards net zero by 2050”, while the IMF suggests it should be $75 a tonne. “We don’t have models which understand [the implications] of this,” Makhlouf says.

Finally, governments need to create safety nets to protect vulnerable parts of the population from price increases. Green warriors might argue that inflation is a small price to pay to prevent planetary catastrophe. Some economists might also mutter that a little of it makes it easier for governments to inflate away debts.

But the 2018 Gilets Jaunes protests in France over fuel price hikes show that when greenflation hits the poor, it can spark populist revolts and prevent badly-needed green reforms. This could easily be repeated in Europe and elsewhere. And while governments cannot magically remove the shock of costs from the reforms needed to fight climate change, they can — and must — soften the pain with intelligent policies. In that sense, the UK gas crisis is a timely and badly-needed wake-up call.

gillian.tett@ft.com

Climate Capital

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