In this paper we analyse the possible effects on prices of a progressive increase in the tax on emissions in a simple two-period New Keynesian model with an AS-AD representation. We then extend the analysis in a medium-scale DSGE model. In both models, emissions increase with production and the green transition is modelled as a gradual increase in the tax on emissions.
We find that an increase in the tax today exerts inflationary pressures, but the expected further increase in the tax tomorrow depresses current demand, putting downward pressure on prices: we show that the second effect is larger. However, if households do not anticipate a future fall in income (because they are not rational or the government is not credible), the overall effect of the transition may initially be inflationary.
