A Divine Coincidence? Do Renewables Shield Inflation from Fossil Fuel-Price Fluctuations?

Abstract

This study investigates the relationship between renewable energy adoption and the sensitivity of inflation to changes in fossil fuel prices across 75 countries over a 50-year period from 1973 to 2022. In the wake of recently increased oil and gas prices leading to inflation surges, the notion of a "divine coincidence" posits that higher shares of renewable energy - on top of fighting climate change - could mitigate fossil fuel price-induced inflation volatility. However, our empirical analysis does not support this hypothesis as we find no evidence that renewable energy adoption reduces the impact of fossil fuel price changes on energy inflation rates. This counter-intuitive result may be attributed to the omission of energy policies, especially price controls, in the data set, potential threshold effects in electricity prices, and trade linkage spillovers. As the world continues transitioning towards a low-carbon economy, it is crucial to understand the implications of this shift on inflation dynamics. Confirming the "divine coincidence" hypothesis in the future could significantly impact the conduct of monetary policy.

Keywords: Inflation, Renewable Energy, Energy Prices, Oil Price, Monetary Policy

JEL Classification: E31, E58, Q42, Q43, Q54