Monetary policy and energy installation: Implications for the European green transition

Policymakers have raised concerns that the required transition to renewable energy sources in the European Union could be stalled by a period of higher ECB policy rates meant to combat inflation. Prior research shows heterogeneous effects of policy rates on sectors with varying industrial characteristics, meaning that renewable technologies may be hit disproportionately by monetary contractions due to their investment requirements, lifecycle stage, and/or dependence on external finance. This paper uses fixed effects panel analysis of 28 European countries to look at the interactions between installed capacity of 10 utility-scale energy technologies, their characteristics, and monetary policy. Over the period of 2001-2024, fossil fuel, hydropower and nuclear technologies remained unaffected by monetary contractions, while a 25 basis point rise in policy rates was associated with a 3.2% decrease in total installed capacity for onshore wind, and a 5.3% decrease for solar PV. Significant interaction effects, using measures of investment intensity and external finance dependence for energy technologies, yield evidence in favour of the interest rate and balance sheet channels of monetary policy transmission. To address endogeneity concerns, we use a two-stage least squares (2SLS) approach in an LCOE specification for the interest rate channel in the energy sector, which confirms these findings. Our results suggest the existence of an unintended bias in contractionary monetary operations; central banks should consider flanking policies (such as preferred interest rates) to offset the disadvantage for renewables.