FRANKFURT (Reuters) – Higher taxes on carbon will hit people’s pockets and make it harder for the European Central Bank to reach its inflation target if governments don’t use the extra revenue well, European Central Bank President Christine Lagarde said on Tuesday.

The European Union has unveiled plans to cap CO2 emissions but, with prices and energy bills soaring across Europe, many economists are worrying about the cost of this green transition.

Lagarde stated that governments should make use of the higher revenue from carbon taxes in order to help people affected by rising prices for fossil fuels as well as to encourage investment into green energy sources.

An ECB conference speaker said, “The effect of carbon pricing depends on whether other consumption taxes are cut, such as electricity taxes and VAT, to directly support vulnerable group or foster green investments.”

If it’s not, higher carbon pricing can reduce purchasing power. This could lead to lower relative prices that will push down the underlying inflation.

An academic paper proving that the carbon tax in Euro area countries has raised headline inflation (which includes energy) but capped growth at other prices, was cited by her.

This could be a problem to the ECB because it would mean that eurozone households and companies are finding life more difficult despite rising demand.

The ECB tried unsuccessfully for 10 years to get sluggish prices growth back at 2%. However, it now faces an unpleasant surge in headline inflation. It is partially due to higher fuel costs and the disappointing supply of energy from European wind farm.