Energy-capital substitution, technological innovation, and monetary policy

Abstract

China has been actively implementing a green development strategy focused on peak carbon and carbon neutrality. The challenge is to avoid the economic fluctuations caused by energy price increases, promote effective substitution of capital for energy, stimulate innovation in energy utilization technology, and implement appropriate monetary policies to resist the negative impact of external supply shocks on the macro economy. This study constructs a new energy utilization technology progress equation within the NK-DSGE framework to reveal the mechanism of energy price-induced technological progress and clarify the substitution path between energy and capital. The study finds that: (1) Rising energy prices drive broad supply-side cost hikes, notably harming capital efficiency and diminishing capital's substitutability for energy. This worsens factor allocation efficiency, potentially inducing an overall demand decrease, thus causing sustained adverse effects on the economy and society (2) China's current energy technology partly reduces economic fluctuations from energy price shocks. Rising energy prices can drive firms to enhance their energy technology, easing the adverse effects of energy price fluctuations. The study notes that the extent of energy technology mitigation of price shocks relies on energy-capital substitution efficiency in production. Advanced energy technology fosters better energy-capital substitutability, curbing the duration and severity of economic stagflation triggered by energy cost hikes. (3) a monetary policy that focuses solely on the core inflation target is more effective than one that focuses on "temporary" price fluctuations represented by energy prices, implying that central banks need a clear policy target system when formulating monetary policies.