Carbon Credit Inflation: The Policy Failure of Global Carbon Markets and the Economics of False Decarbonization

theconvergencys
Nov 20, 2025
5 min read

By Alice Zhao Nov. 14, 2024

I – Introduction

The carbon market was once hailed as capitalism’s answer to climate change. Yet by 2025, the credibility of global carbon offset systems is collapsing. A report from Carbon Market Watch (2025) revealed that 38 % of credits traded on voluntary exchanges represented no measurable emissions reduction, while the European Environment Agency confirmed that the EU ETS (Emissions Trading System) experienced a 23 % oversupply of credits in 2024 alone.

The economic logic behind carbon trading was simple: assign a price to pollution and allow markets to find the cheapest path to decarbonization. Instead, it has created a shadow economy of inflated credits, uneven regulation, and speculative investment. This paper examines the mechanisms behind carbon credit inflation, its macroeconomic implications, and policy reforms necessary to restore market integrity.

II – The Economic Architecture of Carbon Trading

Carbon markets are built on the principle of cap-and-trade: governments set a cap on total emissions, allocate or auction permits, and let firms trade them. Theoretically, this ensures efficiency — polluters who can cut emissions cheaply do so, while others pay for credits.

However, the system depends on accurate measurement, verification, and enforcement. World Bank’s State and Trends of Carbon Pricing Report (2025) shows that global carbon pricing covers only 24 % of emissions, leaving the majority outside any credible market. Moreover, offsets generated in developing countries often lack independent verification. The Guardian Carbon Project Investigation (2024) found that 90 % of rainforest offsets certified by one major global standard were overstated or “phantom.”

In effect, carbon markets have created asset inflation without environmental value, mirroring the speculative bubbles of subprime finance — except this time the collateral is the planet.

III – Mechanisms of Carbon Credit Inflation

Carbon credit inflation arises from three structural flaws:

Over-issuance and baseline manipulation – Projects exaggerate the emissions they would have produced without intervention (“baseline inflation”), generating excess credits. A 2024 Stanford study found that baseline manipulation inflated project credit volumes by up to 46 % in Southeast Asia.
Double counting – Host countries claim reductions toward national targets while foreign firms also claim the same credits to meet offset obligations, violating Article 6 of the Paris Agreement.
Speculative secondary trading – Investment funds treat carbon credits as financial assets divorced from their climate utility. Bloomberg Green (2025) reported that carbon futures trading volume on voluntary markets grew 72 %, even as verified emissions reductions stagnated.

The result is a market where price no longer signals genuine scarcity but policy uncertainty and investor speculation.

IV – Macroeconomic Implications

1. Distorted Incentives

When inflated credits are cheap, firms have little reason to invest in real decarbonization. IEA Modeling (2024) estimates that each $10 decline in the average carbon price delays clean-energy capital investment by $45 billion globally.

2. Fiscal Leakage

Governments that auction credits rely on their sale for public revenue. Oversupply pushes prices down: the EU ETS carbon price fell from €98 to €63 per ton between 2023 and 2024, cutting €11 billion from member-state green budgets.

3. Reputational Risk and Greenwashing

Corporate decarbonization pledges increasingly depend on dubious offsets. When exposed, this erodes consumer trust and investor confidence. According to CDP Global (2025), 58 % of investors now discount voluntary offsets in ESG assessments, undermining the financialization of sustainability.

V – Policy Failures and Institutional Fragmentation

The problem is not merely economic but institutional. Carbon markets evolved piecemeal: the EU ETS, CORSIA (aviation), and voluntary registries like Verra and Gold Standard operate with different methodologies, verification standards, and price signals.

The EU ETS, though the largest compliance market, still gives free allowances to heavy industry, effectively subsidizing polluters.
Voluntary markets, dominated by private certification bodies, suffer from conflict of interest: registries profit from issuing more credits.
Developing nations face governance gaps—weak monitoring, poor enforcement, and political pressure to approve revenue-generating projects regardless of quality.

This fragmentation allows arbitrage between systems, enabling firms to exploit the weakest rules globally while appearing compliant.

VI – Policy Reforms: Toward a Credible Carbon Market

Global Carbon Registry and Unique Identifiers Create an international digital ledger under the UN Framework Convention on Climate Change (UNFCCC) assigning each credit a unique serial number, preventing double counting and fraud.
Dynamic Baseline Adjustment Employ AI and satellite monitoring to update project baselines annually based on observed data, reducing inflation from project self-reporting.
Price Floors and Credit Retirement Ratios The World Bank recommends a minimum carbon price of $50 per ton to incentivize investment. A retirement ratio of 1.5 (i.e., firms must surrender 1.5 credits for each ton emitted) can offset inflationary supply.
Public Verification Audits Require all credits to be subject to independent review by national audit bureaus or international panels, not private registries alone.
Shift to Results-Based Finance Replace up-front credit issuance with post-verification payments for proven emissions reductions. This aligns incentives with measured outcomes rather than promises.

VII – The Political Economy of Reform

Resistance to carbon market reform comes from two sides:

Industry lobbies, which fear higher costs, and
Developing countries, which depend on offset revenues for foreign exchange.

However, the cost of inaction is higher. IMF Fiscal Monitor (2025) warns that unverified offsets could inflate global carbon liabilities by $1.3 trillion by 2030, destabilizing green bond markets and devaluing corporate ESG assets.

A coalition of G20 finance ministries is now pushing for a Global Carbon Integrity Standard (GCIS) to unify verification protocols. If adopted, it could restore investor trust and generate an estimated $240 billion in legitimate carbon trade annually.

VIII – Conclusion

The promise of carbon markets was to turn pollution into a priced commodity and decarbonization into a profit motive. Instead, it has created a speculative economy of paper reductions and illusory climate gains. The evidence is clear: without transparent governance and robust verification, carbon markets risk becoming the next financial bubble.

Policymakers must pivot from volume to value — from trading promises to measuring performance. A globally regulated carbon ledger, AI-based verification, and result-based finance can turn carbon markets from instruments of greenwashing into tools of genuine climate accountability. Only then can markets serve as allies — not illusions — in the fight against climate change.

Works Cited (MLA)

Carbon Market Watch Annual Report 2025. Carbon Market Watch, 2025.
State and Trends of Carbon Pricing 2025. World Bank, 2025.
“Phantom Offsets: Rainforest Credit Investigations.” The Guardian, 2024.
“Carbon Price Collapse in EU ETS.” European Environment Agency, 2024.
“Inflated Baselines in REDD+ Projects.” Stanford Environmental Policy Review, 2024.
“Voluntary Carbon Market Data 2025.” Bloomberg Green, 2025.
IEA Clean Energy Investment Modeling Report 2024. International Energy Agency, 2024.
Fiscal Monitor: Climate Liability Risks. International Monetary Fund, 2025.
CDP Global Investor Survey 2025. Carbon Disclosure Project, 2025.