Do carbon markets matter for inflation? Asymmetric impacts through inflation expectations

Although carbon market trading mechanisms are key to the green transition, the information on the response of inflation to carbon price shocks is still limited. Using data from the California carbon market and the Michigan Survey, this study employs the Nonlinear Auto-Regressive Distributed Lag (NARDL) model to estimate the asymmetric impacts of carbon price shocks on inflation and reveals possible mediating factors. This study finds that the pass-through from carbon price to inflation is asymmetric and operates primarily through the long-run channel, suggesting that the transmission of carbon prices to inflation has a first-round effect through the cost channel. A second-round effect occurs through both short-term and long-term inflation expectations. This effect is more pronounced in short-term inflation expectations compared to long-term expectations. These findings suggest that policymakers should balance the short- and long-run effects of carbon pricing and carefully monitor inflation expectations as a key transmission channel.