How Europe Can Protect the Poor from Surging Energy Prices
IMF Blog, August 3, 2022
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Bibliographic details
- Authors: Oya Celasun, Dora Iakova, Ian Parry
- Published: August 3, 2022
Overview of the shock and key findings
- Since early last year, global oil prices doubled, coal prices nearly quadrupled and European natural gas prices increased almost seven-fold.
- With energy prices likely to remain above pre-crisis levels for some time, Europe must adapt to higher import bills for fossil fuels.
- Governments cannot prevent the loss in real national income arising from the terms-of-trade shock.
- The authors estimate that the average European household will see a rise of about 7 percent in its cost of living this year relative to what was expected in early 2021. This reflects the direct effect of higher energy prices as well as their pass-through to other goods and services.
- Large differences in impact across countries reflect different regulations, policy responses, market structures, and contracting practices.
- The spike in the cost of living could get worse in the event of a cutoff in gas supplies from Russia.
- In most European countries, higher energy prices impose an even heavier burden on low-income households because they spend a larger share of their budget on electricity and gas.
- In Estonia and the United Kingdom, living costs for the poorest 20 percent of households are set to rise by about twice as much as those for the wealthiest.
Assessment of policy responses to date
- Policymakers have largely used broad-based, price-suppressing measures, including subsidies, tax cuts and price controls.
- Suppressing the pass-through to retail prices:
- Delays needed adjustment to the energy shock by reducing incentives for households and businesses to conserve energy and enhance efficiency.
- Keeps global energy demand and prices higher than they would otherwise be.
- Is increasingly costly and is squeezing fiscal space as high prices persist.
- In many countries the cost of broad price-suppressing measures will exceed 1.5 percent of economic output this year.
Recommended policy direction: let retail prices rise and target relief
- Allow the full increase in fuel costs to pass to end-users to encourage energy saving and switching out of fossil fuels.
- Shift from broad-based support to targeted relief such as transfers to lower-income households who suffer the most from higher energy bills.
- Targeted income support estimates:
- Fully offsetting the increase in the cost of living for the bottom 20 percent of households would cost governments 0.4 percent of GDP on average for the whole of 2022.
- Fully compensating the bottom 40 percent would cost 0.9 percent of GDP.
- Design of support:
- The share of the population that receives compensation would vary across countries depending on societal preferences and fiscal space.
- Support should ideally avoid “cliff effects”, with benefits tapering off gradually at higher income levels.
Role of support for businesses and caveats
- Support for businesses can be appropriate if a short-lived price surge would cause otherwise viable firms to fail (for example, if a complete cutoff of gas flows forced temporary rationing to industry).
- Firms that play a critical role in importing and distributing energy may also need support when prices spike.
- In most cases, implementing well-targeted support for firms is difficult without introducing distortions and blunting incentives for energy conservation.
- Since prices are expected to remain high for several years, the case for supporting businesses is generally weak.
This blog reflects research contributions by Anil Ari, Nicolas Arregui, Simon Black, Aiko Mineshima, Victor Mylonas, Iulia Teodoru, and Karlygash Zhunussova.
