How (not) to help with high energy prices

This is not our first rodeo, as they say, or more precisely, it’s not our leaders’ first energy crisis. It is only four years ago that energy costs worsened more dramatically than they have yet done this time around. That’s short enough that most policymakers have direct personal experience of managing a price shock, and not just vague historical understanding (if that).

In 2022, policymakers adapted an old mantra to guide the design of assistance packages for energy prices. They said any subsidies should be “timely, targeted and temporary”. They were right about that. They mostly didn’t follow through. But the shortcomings of yesterday are the experience from which to do better today. So in this column, I go through some of the things we (should have) learnt from the previous crisis for how best to design measures to help people through high energy costs.

The support packages in 2022-23 were big. Really big: more than 3 per cent of a year’s worth of national income in many places, sometimes significantly more. This chart is reproduced from the OECD:

And yet the bulk of this large-scale support was poorly targeted, as you can see in the columns in the chart above. According to the Bruegel think-tank, less than a quarter of the money spent on energy cost assistance in Europe by the summer of 2023 consisted of targeted measures. By far the most money was spent on containing energy prices for all or most households or businesses, rather than directed towards helping those in most need.

For now, the energy price jumps are less dramatic than in 2022. And as my colleague Chris Giles has just set out in a column, conditions are less challenging now than then. But already, political attention is turning towards the need to put in place aid. So it is an advantage to have a previous energy crisis in such fresh memory, in that there is absolutely no excuse for not learning from what was done well or badly four years ago. Here are what I think are the key points to learn from.

Price control confusions

The reason for the ill-targeted spending last time around was the temptation for politicians to tell voters: we’re keeping energy and fuel prices low! (or lower than they would be without our intervention!) But this is expensive, wasteful and inefficient. The UK, for example, capped retail energy prices for everyone, ending up with one of the costliest support packages internationally. That benefited a lot of people who didn’t need help (FT readers, you know who you are) and blunted the incentive to economise on energy use.

Partly because the costs of previous aid are still with us in the form of weaker public finances, there is a chance governments might choose better measures this time. The key here is to help those on low incomes with high energy costs that are hard to avoid — while maintaining, as much as possible, incentives to use energy more efficiently. One way to do so is to subsidise a “social tariff” as described here by the Resolution Foundation. This would make energy available to eligible low-income households at a below-market price, while leaving better-off households to their own devices.

This would target the right beneficiaries. But a social tariff should not cover an unlimited amount of energy use. The Resolution Foundation proposes that 42 per cent of households should be eligible, and that would blunt the incentive to pursue energy efficiency for an awful lot of people.

So it’s worth reviving a feature of the cleverly designed German energy “price brake”, which last time around offered subsidised prices but only for 80 per cent of historical energy consumption (70 per cent for industry). By maintaining the market price on the margin, it would reward those who cut energy use. And it shows how you could also support businesses and not just households.

Another aspect of the price control question is whether to change the way electricity markets work, where prices are set according to the marginal unit of power generated. Where this tends to be gas, a fossil energy price shock propagates faster to the wider economy. This was hotly debated last time and will be hotly debated again. The question is, of course, how you incentivise efficient energy choices if people are not made to pay the marginal cost on the margin. There is also an argument for letting those who could have opted for a fixed-price contract, but chose not to, to face the consequences.

Monetary policy conundrums

Central banks will also have difficult decisions to make. The standard view is that monetary policy should ignore the first-order effects of a supply shock, but act to prevent inflationary repercussions beyond energy prices themselves. So we should expect some monetary tightening. But the energy crisis also hurts growth, which could pull in the opposite direction, depending on the country. Here is a striking observation from Evercore ISI, a financial markets research company, in a note on Tuesday:

Pretty much everywhere in the world the market has responded to the Iran energy shock by pushing up the expected path for interest rates. Everywhere except for Japan, where the initial response was to push the market rate path lower with later/fewer hikes . . . In effect the market bet was that in Japan the negative impact on the real economy will dominate the impact of higher energy prices on inflation.

Even if an inflation problem does emerge, there is no easy path for central banks. It’s hard to justify that the right response to higher prices is to weaken growth further, so as to make it harder for people to keep their jobs and demand wage rises. As I wrote in 2022, central bankers risk being seen as class warriors — on the side of capital owners against labour.

Another problem is that tighter monetary policy can slow down the energy transition that reduces our economies’ exposure to fossil price shocks. Here are the findings from a recent study:

Over the period of 2001–2024, fossil fuel, hydropower and nuclear technologies remained unaffected by monetary contractions, while a 25 basis point rise in policy rates was associated with a 3.2% decrease in total installed capacity for onshore wind, and a 5.3% decrease for solar PV.

If standard monetary policy must frustrate a strategically necessary restructuring of the economy, we may want to rethink it in a way we did not do last time. The goal, whether through new monetary policy tools or some sort of fiscal-monetary co-operation, should be to shield strategic investment incentives from the policies deemed necessary to address inflation.

Energy saving is achievable and necessary

The above points already touch on the need to maintain incentives to improve energy efficiency generally and reduce reliance on imported fossil energy specifically. It is worth remembering that in most European countries, it proved possible to cut fossil energy use in a sustained way. And while Germany has had a problem of industrial contraction, manufacturing has held up well in the rest of the EU and in the UK.

It is also crucial to be smart about energy saving. The growing presence of renewables means that during certain times of the day, electricity remains cheap. So the oil and gas price shock has translated into highly volatile daily price cycles, as my colleagues have reported. (Note how Spain’s strong deployment of renewables has left it in a better place than many other countries.)

The diurnal spikes show how it is essential to create incentives to shift whatever energy demand can be moved away from the peaks. It is inconceivable to do this without the price mechanism. This means that, if anything, end users must be made more aware of the market spot price (households that face the same price through the day and night have no reason to switch their consumption around). To the extent possible, subsidies should be linked to this sort of behaviour and strong incentives put in place to expand energy storage.

Windfall taxes are a no-brainer

Maintaining marginal pricing means windfalls for all but the marginal producers. They can be taxed to fund targeted support schemes, while leaving profits high enough to maintain sufficient incentives to expand supply capacity. This really should be a no-brainer.

Being a no-brainer is rarely enough to pass political muster. But taking on board the many lessons from our most recent energy crisis should, at least, raise the bar. There is no excuse for making the same mistakes again.

Other readables

• Lars Calmfors, the Swedish economist who advised Sweden against joining the euro at the turn of the century, has led an excellent new investigation into that same question. He has come around to thinking that the time is now right. 

• The UK is slowly becoming more ambitious in its relations with the EU, but still seems to will the end without willing the means.

• Jürgen Habermas has died.

• The EU has finally published its plan for a pan-European “28th” corporate regime that should make it easier to scale up across the bloc.