Up in the air: How do carbon policy shocks affect air travel?

This study assesses the impact of the EU Emissions Trading Scheme (EU ETS) on air travel demand and supply in Europe. Using vector autoregression (VAR) methodology enriched with an external instrument, we analyse how carbon pricing shocks affect passenger numbers on domestic, intra-EU, and extra-EU flights across Europe, alongside examining the effect on the number of flights. This is done for the EU as a whole, and separately for Germany, United Kingdom, France, Italy, and Spain. We document significant reductions in domestic and intra-EU flights, while extra-EU flights are not found to be affected by carbon price shocks. Moreover, we show that carbon pricing policies lead to significant increases in air transportation prices. Overall, flight frequency is found to decrease more than passenger numbers, indicating airlines' strategic adjustments to mitigate carbon-related costs while maintaining operational efficiency. Our study emphasizes the importance of understanding these effects for informing future policy decisions and business practices in the aviation industry. • Carbon pricing shocks significantly reduce domestic and intra-EU flights. • Extra-EU flights remain unaffected by EU ETS carbon pricing policies. • Airlines pass increased emission costs to consumers through higher airfares. • Flight frequency decreases more than passenger numbers due to strategic adjustments. • Findings provide insights for policymakers on carbon policies in aviation.