Energy and inflation: theory and practice

The economics textbook indicates that when there is an increase in the price of a good or input in production, let the market adjust.

NewsEditor
NewsEditor
14 September 2022 Wednesday 16:42
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Energy and inflation: theory and practice

The economics textbook indicates that when there is an increase in the price of a good or input in production, let the market adjust. For example, if the price of gas rises, consumers, be they families or companies, must face the rise and thus consume less. European governments do not follow this recommendation. In effect, they put price controls, give subsidies and reduce taxes on energy products. Policymakers are concerned about the distributional consequences of rising energy prices, but blanket subsidies are not the best way to fix the problem. The objective of protecting the weakest, distorting prices less, is achieved with direct subsidies

The Kremlin's strategy is that Europe, to avoid a social explosion, presses to end the war in Ukraine this winter. Russia has already closed the Nord Stream 1 gas pipeline and now only the Turkstream remains. Russian gas has gone from representing 40% of European consumption last year to 9% today. Gas reserves are at more than 80%, but consumption will depend on how harsh the winter is. European countries promise to protect consumers, Germany with a package of 65,000 million euros (which brings the total aid to 95,000 million euros), France with 64,000 million euros, Italy with 52,000 million euros. Liz Truss, the new British Conservative Prime Minister, promises aid to consumers for two years and to businesses for six months. The cost of the plan will depend on the evolution of energy prices, but there are estimates that point to up to 150 million pounds. These programs want to be financed with a combination of levies on energy companies, tax increases and deficits, and will moderate inflation in the short term, but will increase it in the medium and long term by stimulating demand. Larry Summers, former US Treasury Secretary, has recently claimed, with his characteristic lack of political correctness, that the UK's strategy of committing to unlimited subsidies reminded him of populist policies in South America that had produced very bad results. .

The EU's energy ministers met last Friday and asked the European Commission to specify the five shock measures it had proposed: an electricity saving plan, a cap on income from renewable and nuclear energy production electricity, a windfall profit tax on oil and gas companies, a cap on the price of gas paid to Russia, and solving the liquidity problems of companies trying to hedge fluctuations in energy prices using the futures market. It will be difficult to obtain the necessary consensus, but the energy union is now as necessary as the banking union was in 2012.

The restrictions with which public policies in the field of energy have to operate are formidable, but it would not hurt not to forget the principles on which they should be based: protect the weak by maintaining price signals to encourage energy saving, and finance aid programs without harming the macroeconomic balance or the incentives to invest so that the energy transition is possible.

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