European carbon pricing in boom and bust times

In this study, we explore the relationship between European carbon prices, energy prices and the macroeconomy in boom and bust times. Utilizing a smooth transition structural VAR model, we analyze monthly data spanning from 2006 to 2023. Our model benefits from identification through non-Gaussianity and the correlation with external carbon and energy shock series. Notably, our analysis reveals heterogeneous effects observed across two distinct regimes of economic activity and when considering the cost pass-through to the transport sector specifically. Furthermore, our findings support that crises affect carbon prices, but challenge the notion of a strengthened linkage between carbon prices and economic performance in recent periods. Linking carbon price dynamics to the business cycle allows to discuss the role of a flexible emission cap in enhancing the effectiveness of carbon pricing across various economic conditions. This is particularly relevant for the recent extensions of the EU ETS to sectors like road transportation.