Carbon pricing and inflation expectations: Evidence from France

Abstract

We study how firms’ price expectations and decisions are affected by carbon pricing, using a survey of French manufacturing firms. Exogenous variations in the price of carbon are obtained by high-frequency identification. A change in carbon price increases firms’ inflation expectations as well as their own expected and realized price growth. Initially, positive forecast errors emerge, but over time, the impact on price expectations proves to be more enduring than on actual price growth, leading to negative forecast errors in the medium- to long-run. Furthermore, our analysis reveals that firms’ responses to these carbon pricing shocks exhibit considerable heterogeneity. Low energy-intensive firms are worse at forecasting the effects of the shock on the evolution of their own prices and firms with narrower profit margins are less able to pass through the increase in energy costs to the prices of their final products. These findings align with models of information rigidities, shedding new light on how firms navigate and adapt to carbon pricing policies.