Untangling the entanglement of US monetary policy uncertainty and European natural gas and carbon prices

Owing to the Russia-Ukraine conflict, the price of natural gas in Europe fluctuated significantly in recent years. As natural gas in Europe is highly dependent on imports, import prices are inevitably affected by monetary policy uncertainties. Additionally, monetary policy uncertainty has a significant impact on financial markets. As a unique financial market, the impact of monetary policy uncertainty on the carbon market remains unclear. Therefore, we conduct a systematic study of the relationships between monetary policy uncertainty, European imported natural gas prices, and carbon prices in the last three phases of European Union emission trading scheme. This study uses the Dynamic conditional correlation Generalized autoregressive conditional heteroskedastic (DCC-GARCH) model and Nonlinear auto-regressive distributed lag (NARDL) model to comprehensively analyze the correlation between these three variables, including volatility correlations and trend correlations. The results of these two models can support each other. In addition, it revealed the asymmetry of the short-term impact and long-term impact of monetary policy uncertainties and imported natural gas prices on the carbon prices trend. The results show that the dynamic conditional correlations between carbon and gas prices are mostly positive, as is the correlation between natural gas prices and monetary policy uncertainty. The dynamic conditional correlations between carbon prices and monetary policy uncertainty gradually decreases and changes from positive to negative in 2015. Moreover, monetary policy uncertainty has asymmetric effects on carbon prices in each of the studied phases, but natural gas prices have asymmetric effects only in Phases 2 and 4. Based on the findings, some policy proposals are provided for the development of the carbon markets.