Can Energy Subsidies Help Slay Inflation?

IMF Working Papers, April 5, 2024

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Documents the transmission of oil supply shocks empirically in the United States and the Euro Area.
Uses a New Keynesian modeling framework to study conditions under which energy subsidies can curb inflation.
Considers both closed-economy and multi-country settings, including scenarios where a small group of countries jointly adopt subsidies.

A consumer energy subsidy may be counterproductive as an inflation-fighting tool when applied globally or in a segmented market, under empirically plausible conditions about wage-setting.
There is more scope for energy subsidies to reduce core inflation and stimulate demand if introduced by a small group of countries which collectively do not have much influence on global energy prices.
The conditions under which consumer energy subsidies reduce inflation are quite restrictive.
Consumer energy subsidies can be counterproductive if the resulting increase in external debt is high enough to trigger sizeable exchange rate depreciation.
Exchange rate depreciation risks are more likely in emerging markets with shallow foreign exchange markets.
If the primary goal of fiscal measures responding to spikes in energy prices is to shield vulnerable households, targeted transfers are much more efficient: they achieve household protection at lower fiscal cost and transmit less to core inflation.

Avoid broad consumer energy subsidies as a general anti-inflation tool unless specific wage-setting and external-financing conditions are satisfied.
Consider collective action among small, low-influence energy-consuming countries only if their joint adoption does not affect global energy prices materially.
Monitor external debt dynamics carefully when deploying consumer energy subsidies to avoid triggering exchange rate depreciation that would undermine inflation objectives.
Prioritize targeted transfers to vulnerable households when the objective is social protection, because they are more fiscally efficient and have smaller effects on core inflation.