The EU’s energy transition is projected to have a significant impact on green investment but a smaller one on aggregate investment. Achieving both the current 2030 emission target and an illustrative 2035 target would result in an annual green investment increase of around 1.6 percentage points of GDP at its peak and averaging 1.3 percentage points of GDP during 2026-2035 (2.2 trillion euros in cumulative terms). However, higher green investment partly substitutes for lower other—particularly brown—aggregate investment, causing the overall increase in aggregate investment to rise by just 1.2 percentage points of GDP at its peak (1 percentage point of GDP on average). This figure falls roughly in the middle of existing "bottom-up" and "top-down" estimates.
The policy mix shapes these investment responses and their effects on energy prices. The greater the reliance on green subsidies, the larger the increases in both green and aggregate investment are, all else equal. For example, compared to a hypothetical scenario in which the EU’s emission goals are fully met by expanding the scope and allowance price levels of its emission trading schemes and the associated revenues are fully rebated to households, the peak response in aggregate investment increases by about a quarter (0.3 percentage points) if about two-thirds of carbon pricing revenues are instead recycled—two-thirds of which into subsidies to renewables and the other third split equally between subsidies to electric vehicles (EVs), building insulation, and electricity-based heating (heat pumps).
The EU’s energy transition is found to have modest macroeconomic implications for demand, prices, interest rates, and exchange rates for a policy mix that combines carbon pricing, green subsidies, and labor tax reductions. Higher carbon pricing raises inflation and reduces output in the short term, as well as real incomes, consumption, and—because the exchange rate appreciates in expectation of a reduced long-run fossil fuel imports bill—exports, with higher investment more than offsetting these effects after two years—starting from 2028. Even if the central bank looks through the direct impact of higher carbon prices on headline inflation, this creates some short-term output-inflation trade-off, leading the central bank to ease monetary policy only slightly in the specific simulations run in this paper. When added to the policy mix, well-designed green subsidies mitigate the output-inflation trade-off by containing the rise in energy prices and inflation while supporting investment and growth.
The net fiscal cost of the energy transition appears to be modest provided a fraction of future carbon pricing revenues is used to fund public investment needs. For example, assuming an illustrative 40 percent public share in aggregate investment needs—the public investment cost of the transition is less than 0.5 percent of GDP annually, leaving net fiscal space that could be used for other policy objectives. Large future carbon pricing revenues offer an opportunity to address market failures (e.g. in innovation and deployment) and reduce existing distortions (e.g. to labor and capital). At the same time, alternative revenue uses entail trade-offs between growth, energy price, energy security, fiscal, and income distribution goals.
