The effects of temperature shocks on energy prices and inflation in the Euro Area

Abstract

This paper traces the existence of an energy transmission channel of temperature anomalies to Euro-Area inflation. We show that, on average, warmer temperature shocks elicit a negative energy demand shift, exerting moderate deflationary pressure. By looking into several asymmetries and macroeconomic indicators, we rationalize that evidence as signaling that the “turn-off-heating” effect in Europe outweighs the “turn-on-cooling”. This result becomes clearer when energy market responses are decomposed into gas and electricity components. Weak inflationary effects from non-energy items are at play when the shock hits during warm seasons. A persistent inflationary tendency manifests when food and energy prices rise, an outcome emerging only when negative anomalies – cold spells – hit. These findings shed new light on monitoring price stability due to global warming.