How inflation develops is ultimately determined by monetary policy. But inflation is continuously affected by cyclical and structural forces that the central bank must take into account. Examples of the latter are globalisation and digitalisation, which have had a dampening effect on inflationary pressures in recent decades.

If the climate transition initially leads to higher inflationary pressures, a challenge for monetary policy will arise: To maintain confidence in the inflation target at as low a cost, in the form of lower demand, output and employment, as possible.^[7] For a discussion of monetary policy challenges, see, for example, Schnabel (2022). Time plays a central role here: The longer inflation is allowed to remain high, the greater the risk of expectations being affected in the long term, and the greater the real economic costs will be of bringing inflation back down.

One specific challenge is therefore to try and determine the extent to which inflation will rise persistently. If long-term inflation expectations do not rise, that is, economic agents see the price increases as more transitory, it is easier for monetary policy to disregard them and refrain from counteracting them with tighter policy. Assessing how higher energy prices and negative supply effects affect inflation in the long term is not in itself a new challenge, but something that monetary policy has always had to deal with from time to time.

One possibility is that investments in new technologies are made so soon and are so large that their effect on demand in the economy not only dampens but also dominates the negative supply effect that arises when CO2-intensive technologies are phased out. In such a scenario, the net effect on the level of activity in the economy will be positive and higher inflation will to a large extent be demand driven.^[8] See Schnabel (2022). Monetary policy considerations will then be easier, as a tighter monetary policy is motivated to dampen both inflation and demand.

It should be emphasised that although the climate transition would give rise to a broader increase in inflation, such a development would in one respect be easier to manage than when inflation is persistently too low. Since the global financial crisis, there have been problems in many countries in bringing inflation up to the target. One reason is that the global real equilibrium rate has fallen to historically low levels. Driving forces behind this development that are often highlighted include demographic factors and high global savings, that is, conditions that monetary policy cannot influence.^[9] See, for example, Lundvall (2020). One consequence has been that central banks' policy rates have needed to be cut to ever lower levels. But there is a limit as to how far the policy rate can be cut, and in many countries it has been at or near this lower bound for a long time. It has therefore been difficult to make monetary policy sufficiently expansionary. When it comes to counteracting excessively high inflation by raising the policy rate, there is no corresponding restriction.