Discussion paper

DP19085 Can Energy Subsidies Help Slay Inflation?

Many countries have used energy subsidies to cushion the effects of high energy prices on households and firms. We use a New Keynesian DSGE modeling framework to identify the conditions under which these policies can curb inflation, drawing on empirical evidence about energy shock transmission from proxy VARs. We show formally that, when implemented globally or in segmented energy markets, a consumer energy subsidy is equivalent to taxing energy use by firms and is counterproductive in fighting inflation under empirically plausible characterizations of wage-setting. We find more scope for energy subsidies to reduce core inflation if introduced by a small group of countries which collectively do not have much influence on global energy prices. However, even here the subsidies can be counterproductive for inflation as they weaken the exchange rate. We also show that targeted transfers are more efficient than subsidies if the aim is to shield vulnerable households.

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Citation

Erceg, C, M Kolasa, J Lindé and A Pescatori (2024), ‘DP19085 Can Energy Subsidies Help Slay Inflation?‘, CEPR Discussion Paper No. 19085. CEPR Press, Paris & London. https://cepr.org/publications/dp19085