Social Europe

politics, economy and employment & labour

  • Themes
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter

Taking the heat out of energy prices

Peter Bofinger 7th March 2022

Instead of higher interest rates, Peter Bofinger urges lower VAT on energy and temporary suspension of the CO2 trading system.  

energy prices,emissions trading
Energy prices have risen by a third in a year (Daisy Daisy / shutterstock.com)

Last month, annual inflation in the euro area reached a record 5.8 per cent—it was just 0.9 per cent a year earlier. The wellspring is the unprecedented rise in energy prices.

Energy raw materials are around 130 per cent more expensive, on a euro basis, than a year ago. For consumers, this means an increase in energy prices of almost 32 per cent over that period. As spending on energy accounts for around 10 per cent of a household’s basket of goods, this results in an increase in the overall index of around three percentage points—the inflation rate, excluding energy, is accordingly 3.0 per cent.

The explosion of energy prices is a huge challenge for Europe. It is detrimental to the reputation of the European Central Bank, especially in Germany, although the shocks on energy markets cannot be related to its monetary policy. It has serious social consequences, as poor households spend a much larger share of their income on energy than wealthy households—energy poverty is a rising problem. And it threatens public acceptance of financially-mediated climate policies—carbon taxes and the European Union Emissions Trading System—as key instruments to reduce greenhouse-gas emissions.

Excessive stimulation?

So how should policy-makers deal with this shock? The ECB, whose mandate is to ensure price stability, is first in the frame. Many who have long been critical of the ECB’s expansionary monetary policy see high inflation as their vindication.


Our job is keeping you informed!


Subscribe to our free newsletter and stay up to date with the latest Social Europe content. We will never send you spam and you can unsubscribe anytime.

Sign up here

The view that excessive monetary stimulation is the culprit for inflation is however countermanded by the fact that in 2021 households in the euro area consumed less as a share of gross domestic product than ever. Private demand can therefore be safely ruled out as a driver of inflation.

Were the ECB to raise interest rates now, it would merely dampen overall demand, already suffering from the loss of purchasing power due to high energy prices and the political and economic uncertainty triggered by the Ukraine war. The effect on energy prices specifically would be indirect and, given the current tensions on the energy markets, insufficient.

From a theoretical perspective, it is well-known that monetary policy is not well equipped to deal with a supply shock. This draws attention to the possibilities of economic and fiscal policies. Note in this context article 1 of Germany’s Stability and Growth Act of 1967, which explicitly commits policy-makers to the goal of price stability:

The Federal Government and the Länder shall observe the requirements of macroeconomic equilibrium in their economic and fiscal policy measures. The measures shall be taken in such a way that, within the framework of the market economy, they contribute simultaneously to the stability of the price level, a high level of employment and external equilibrium with steady and adequate economic growth.

A similar statement can be found in article 3 of the Treaty on European Union:

The Union shall establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability …

Targeted relief

Compared with the ECB’s toolbox, economic and fiscal policies can directly affect the price of energy. One option, proposed by Sebastian Dullien and Isabella Weber, would be price controls. But these are difficult to reconcile with a market economy and would place the burden of higher commodity prices unilaterally on energy suppliers.

The better solution, practised by Spain, is to relieve consumers by temporarily reducing value-added tax on energy. This can provide targeted relief for households. From a social point of view, such a measure can be justified by the disproportionate burden faced by lower-income households. One could think of adding into the social balance a surcharge on income tax for rich households; in addition, a windfall tax on the profits of energy providers could be considered. In principle, however, the VAT relief should be financed by government deficits.


We need your support


Social Europe is an independent publisher and we believe in freely available content. For this model to be sustainable, however, we depend on the solidarity of our readers. Become a Social Europe member for less than 5 Euro per month and help us produce more articles, podcasts and videos. Thank you very much for your support!

Become a Social Europe Member

This is comparatively unproblematic, as the fiscal rules in the Stability and Growth Pact remain suspended this year. Indeed, sustaining the exemption in 2023 should be considered in light of the economic and, above all, energy-policy challenges posed by the war in Ukraine.

Temporary suspension

What are the other possibilities for action at the European level? Here, the Emissions Trading Scheme would be the prime focus. Until a few days ago, the price of carbon-dioxide certificates had risen very sharply, tripling within a year to a peak of €96 per ton and so contributing to the inflation in energy prices. It has however slumped very recently, as markets have anticipated temporary suspension of the system.

One reason for the CO2 price explosion is the rise in the price of natural gas: electricity is increasingly being produced by coal-fired power plants, which require more CO2 certificates than gas-fired. But there are signs that the CO2 price is more and more being driven by hedge and investment funds which have discovered certificates as an attractive investment alternative.

The energy price shock is thus exacerbated by certificate trading. The principle of CO2 pricing by the financial market should therefore be put to the test once again.

At its core, climate policy aims for a CO2 price that rises steadily over time. To give companies planning certainty, the price path to 2030 should be as predictable as possible. But this predictability opens up almost risk-free profits for speculators. With interest rates close to zero, they immediately drive the certificate price up to the level expected in 2030. Contrary to what policy-makers intend, this results in an abrupt price increase, which overwhelms the economy and consumers.

Thus, instead of the dysfunctional certificate trading, one should also rely on a CO2 tax in the EU. An experimental study shows that direct pricing through taxes leads to significantly lower CO2 emissions.

As a short-term measure, the ETS could be suspended temporarily until the situation on global energy markets has calmed down. For the target of CO2 reduction, current energy prices are much higher than envisaged, even by ambitious climate activists.

This is a joint publication by Social Europe and IPS-Journal

Peter Bofinger
Peter Bofinger

Peter Bofinger is professor of economics at Würzburg University and a former member of the German Council of Economic Experts.

You are here: Home / Economy / Taking the heat out of energy prices

Most Popular Posts

Russian soldiers' mothers,war,Ukraine The Ukraine war and Russian soldiers’ mothersJennifer Mathers and Natasha Danilova
IGU,documents,International Gas Union,lobby,lobbying,sustainable finance taxonomy,green gas,EU,COP ‘Gaslighting’ Europe on fossil fuelsFaye Holder
Schengen,Fortress Europe,Romania,Bulgaria Romania and Bulgaria stuck in EU’s second tierMagdalena Ulceluse
income inequality,inequality,Gini,1 per cent,elephant chart,elephant Global income inequality: time to revise the elephantBranko Milanovic
Orbán,Hungary,Russia,Putin,sanctions,European Union,EU,European Parliament,commission,funds,funding Time to confront Europe’s rogue state—HungaryStephen Pogány

Most Recent Posts

reality check,EU foreign policy,Russia Russia’s invasion of Ukraine—a reality check for the EUHeidi Mauer, Richard Whitman and Nicholas Wright
permanent EU investment fund,Recovery and Resilience Facility,public investment,RRF Towards a permanent EU investment fundPhilipp Heimberger and Andreas Lichtenberger
sustainability,SDGs,Finland Embedding sustainability in a government programmeJohanna Juselius
social dialogue,social partners Social dialogue must be at the heart of Europe’s futureClaes-Mikael Ståhl
Jacinda Ardern,women,leadership,New Zealand What it means when Jacinda Ardern calls timePeter Davis

Other Social Europe Publications

front cover scaled Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship
Women Corona e1631700896969 500 Women and the coronavirus crisis
sere12 1 RE No. 12: Why No Economic Democracy in Sweden?

ILO advertisement

Global Wage Report 2022-23: The impact of inflation and COVID-19 on wages and purchasing power

The International Labour Organization's Global Wage Report is a key reference on wages and wage inequality for the academic community and policy-makers around the world.

This eighth edition of the report, The Impact of inflation and COVID-19 on wages and purchasing power, examines the evolution of real wages, giving a unique picture of wage trends globally and by region. The report includes evidence on how wages have evolved through the COVID-19 crisis as well as how the current inflationary context is biting into real wage growth in most regions of the world. The report shows that for the first time in the 21st century real wage growth has fallen to negative values while, at the same time, the gap between real productivity growth and real wage growth continues to widen.

The report analysis the evolution of the real total wage bill from 2019 to 2022 to show how its different components—employment, nominal wages and inflation—have changed during the COVID-19 crisis and, more recently, during the cost-of-living crisis. The decomposition of the total wage bill, and its evolution, is shown for all wage employees and distinguishes between women and men. The report also looks at changes in wage inequality and the gender pay gap to reveal how COVID-19 may have contributed to increasing income inequality in different regions of the world. Together, the empirical evidence in the report becomes the backbone of a policy discussion that could play a key role in a human-centred recovery from the different ongoing crises.


DOWNLOAD HERE

ETUI advertisement

The EU recovery strategy: a blueprint for a more Social Europe or a house of cards?

This new ETUI paper explores the European Union recovery strategy, with a focus on its potentially transformative aspects vis-à-vis European integration and its implications for the social dimension of the EU’s socio-economic governance. In particular, it reflects on whether the agreed measures provide sufficient safeguards against the spectre of austerity and whether these constitute steps away from treating social and labour policies as mere ‘variables’ of economic growth.


DOWNLOAD HERE

Eurofound advertisement

Eurofound webinar: Making telework work for everyone

Since 2020 more European workers and managers have enjoyed greater flexibility and autonomy in work and are reporting their preference for hybrid working. Also driven by technological developments and structural changes in employment, organisations are now integrating telework more permanently into their workplace.

To reflect on these shifts, on 6 December Eurofound researchers Oscar Vargas and John Hurley explored the challenges and opportunities of the surge in telework, as well as the overall growth of telework and teleworkable jobs in the EU and what this means for workers, managers, companies and policymakers.


WATCH THE WEBINAR HERE

Foundation for European Progressive Studies Advertisement

The winter issue of the Progressive Post magazine from FEPS is out!

The sequence of recent catastrophes has thrust new words into our vocabulary—'polycrisis', for example, even 'permacrisis'. These challenges have multiple origins, reinforce each other and cannot be tackled individually. But could they also be opportunities for the EU?

This issue offers compelling analyses on the European health union, multilateralism and international co-operation, the state of the union, political alternatives to the narrative imposed by the right and much more!


DOWNLOAD HERE

Hans Böckler Stiftung Advertisement

The macroeconomic effects of re-applying the EU fiscal rules

Against the background of the European Commission's reform plans for the Stability and Growth Pact (SGP), this policy brief uses the macroeconometric multi-country model NiGEM to simulate the macroeconomic implications of the most relevant reform options from 2024 onwards. Next to a return to the existing and unreformed rules, the most prominent options include an expenditure rule linked to a debt anchor.

Our results for the euro area and its four biggest economies—France, Italy, Germany and Spain—indicate that returning to the rules of the SGP would lead to severe cuts in public spending, particularly if the SGP rules were interpreted as in the past. A more flexible interpretation would only somewhat ease the fiscal-adjustment burden. An expenditure rule along the lines of the European Fiscal Board would, however, not necessarily alleviate that burden in and of itself.

Our simulations show great care must be taken to specify the expenditure rule, such that fiscal consolidation is achieved in a growth-friendly way. Raising the debt ceiling to 90 per cent of gross domestic product and applying less demanding fiscal adjustments, as proposed by the IMK, would go a long way.


DOWNLOAD HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube