The UK’s National Institute of Economic and Social Research (NIESR) has conducted a new study examining the consequences of an unexpected increase in the cost of carbon dioxide (CO2) by US$100 per tonne. The research reveals that such an escalation would lead to short-term inflationary pressures and a decline in GDP across most OECD countries.
The impact is projected to be more significant in economies heavily reliant on carbon-intensive activities. This aligns with the Bank of England’s stress-testing exercises, which demonstrate the potential for carbon prices to surge from the current level of US$60 per tonne to over US$1,000 per tonne by 2050.
Utilising the National Institute Global Macroeconomic Model (NiGEM), NIESR illustrates the anticipated macroeconomic fallout resulting from a sudden and uniform carbon price increase. The study indicates that a US$100 per tonne rise in the carbon price would lead to substantial trade losses for countries heavily dependent on fossil fuel exports, while constraining GDP growth. Most OECD countries would experience a decline in GDP ranging from 1% to 2%. However, carbon-intensive nations like Russia, South Africa, and India would face more significant economic repercussions. The report suggests that reinvesting carbon tax revenues into the economy, such as through income tax cuts, could help mitigate the adverse effects.
Furthermore, the study highlights that a carbon price of US$100 per tonne would increase the post-tax price of coal relative to renewable energy by more than 300%. Similarly, gas and oil prices would rise by 60-70% compared to renewables. As a result, total energy demand would decline by approximately 15% relative to the baseline, with coal demand dropping by 35% and accounting for over 50% of the decline. Countries with higher energy intensity and a greater reliance on carbon-intensive fuels, such as Russia (due to high energy intensity) and India (due to heavy coal reliance), would face particular vulnerability during the energy transition and with the rising carbon price.
The NIESR study underscores the challenges associated with sudden increases in carbon prices, including potential inflationary effects, GDP constraints, and the need for a managed transition towards cleaner energy sources. It highlights the importance of considering effective policy measures and reinvesting carbon tax revenues to support economies in navigating these challenges while facilitating the transition to a low-carbon future.
