Fossil Fuel Shocks Spark Call for New Macroeconomic Settlement in EU

The New Economics Foundation (NEF) has studied the impact of fossil fuel price shocks on inflation in the European Union (EU). They found that a 50% shock to these prices would add between 0.8 and 1.8 percentage points to headline inflation across EU countries, which is significant compared to the ECB's 2% inflation target.

The NEF argues that the current monetary policy framework in Europe is not only ill-suited to containing these shocks but also actively suppressing the transition to renewable energy. They propose a new macroeconomic settlement built on closer coordination between monetary and fiscal policy, which would prioritize energy resilience and support the transition directly.

The report calls for the ECB to act deliberately on energy security through green dual refinancing rates, a decarbonised collateral framework, and credit guidance. It also suggests that interest rates may not be the best tool to address supply-driven inflation, and instead proposes using fiscal and regulatory tools to address costs at their source.

The NEF argues that speeding up the transition to renewable energy is crucial to making Europe more resilient to volatile fossil fuel imports. They point out that the current electricity market design clearly underlines this argument, as gas set the marginal price of electricity 55% of the time in 2022 despite generating only 19% of the EU's power.