The Russian invasion of Ukraine and the turning off of the gas tap have pushed up gas prices in Europe sharply. Also with the recent price drop, the energy bill threatens to become unaffordable. There are even stories in the media about people who voluntarily have the gas turned off, or children who have to go to school without food due to lack of money.
Economists generally believe that governments should stay away from price interventions and provide support through income policies. However, there are good reasons to view the market for an essential product like energy differently. Now that income support proves impracticable, the government will also have to consider instruments such as a temporary price cap for sales to consumers. For example, by maximizing prices at the level at the beginning of 2022.
There are good arguments to be made from an economic perspective. We name two. Ideally, a government offers targeted support to vulnerable households through income policy – for example through the system of benefits, taxes and allowances. Then the price can balance supply and demand. Unfortunately, additional income support seems impracticable for the Dutch implementing organisations. Economists learn that you then have to weigh the disadvantages of a price ceiling against the price of sitting still. And that price is increasing day by day.
School achievements
Inaction means a great increase in uncertainty, stress, debt and poverty. This can have major negative consequences for society. Think of declining school performance, increasing health care costs and a greater demand for municipal services. Preventing such a scenario is very beneficial.
A price ceiling does have drawbacks, but we have to weigh them against the costs of sitting idle. A price intervention is an acceptable instrument if alternatives are not available.
Second, high energy prices destabilize the economy and affect household inflation expectations. Higher inflation expectations can push inflation up for a longer period of time. When the government intervenes directly on energy costs, this actually limits inflation. Moreover, applying a price ceiling makes it easier for employees to estimate future inflation and reduces the chance of a wage-price spiral. It also directly leads to greater disposable income for households. Higher spending also reduces the likelihood of a recession.
Sustainability
A smart price cap should meet three conditions. In the first place, the measure must be temporary. The intervention should be reversed as soon as it is possible to adequately support households through income policy, market prices have returned to normal, or we have succeeded in making them sufficiently sustainable.
A period of six months, until the end of winter, seems reasonable at first sight. Secondly, energy companies must be compensated for the additional costs they incur when purchasing energy on the market. Finally, it is wise to only apply the ceiling to a certain part of the energy consumption. This gives households an incentive to save energy.
It is important to note that a price cap does not hinder the energy transition. The proposed design will continue to provide an incentive to pay attention to energy consumption. For lower incomes, even with lower rates the incentive to save is strong. Moreover, it is highly questionable how much effect the price still has on energy savings. Rapid insulation is not an option for many people, due to a shortage of professionals or materials. At some point, turning off the heating is the only option. A higher price does not lead to more savings, but to poverty.
110 billion
Price interventions are no longer a taboo in neighboring countries. Authoritative foreign economists are now also arguing for it. In Germany, the United Kingdom and France, governments are working on proposals for rapid interventions in the energy market. Now that Brussels has proposed a tax on excess profits, member states can look forward to more than 110 billion euros in additional tax revenues. This can flow directly back to the citizen via a price ceiling. The European energy saving proposals will hopefully lead to a further fall in energy prices. This increases the affordability of this proposal.
In normal times, you will not easily hear economists arguing for price caps. However, the current energy market is not a perfect market. If you consider that a smart price ceiling for energy does not delay the necessary sustainability, is feasible, gets money in the right place quickly and can dampen inflation, we think it is a tool that should be looked at seriously.
Economics professors:
Dirk BezemerUniversity of Groningen
Wimar BolhuisUniversity of Leiden
Jaap BosUniversity of Maastricht
Erwin BulteWageningen University
Arnoud BootUniversity of Amsterdam
Clemens KoolUniversity of Maastricht
Hans SchenkUniversity of Utrecht
Esther Mirjam SentRadboud University
Irene van StaverenErasmus University Rotterdam
Tom van VeenUniversity of Maastricht