Eurogroup
Brussels, 29 September 2021 ecfin.cef.cpe(2021)6708647
Issues note
Inflation and implications of recent energy price developments in the Euro Area
Higher prices have been evident across the euro area over the past quarter, and particularly so in relation to supply chains and wider input costs. It is notable that forecasts for euro area inflation have been repeatedly revised upwards over the course of 2021, although there is an assumption that much of this is transitory in nature.
In recent months, energy prices have accelerated markedly across the euro area and are adding to inflation. The rebound from the energy price collapse in spring 2020 has been central to this, but new developments have also played a large part, including gas prices, which have increased sharply as the year has progressed. In turn, this is affecting electricity prices, notably in recent months.
There are several broad issues related to energy price changes ranging from inflationary implications, to climate change, to issues around equity as well as the appropriate policy responses. These are summarised below.
Inflationary implications: Energy prices are an important determinant of inflation and are one of the most salient costs for households and businesses. One key issue is the extent to which recent energy price movements are permanent or transitory. The former can be expected to have bigger implications for growth and inflation given the potential for higher energy prices to affect supply chains, profit margins and the likelihood for pass through to consumer prices and the wage bargaining process.
From an economic perspective, higher energy prices have the potential to slow the recovery.
The assumptions around electricity, gas and overall prices are a key input in preparing budgetary plans, particularly in light of recent volatility. Relatedly, scenarios around energy
price developments and the implications for growth and fiscal aggregates could be particularly informative at this time.
Climate change: Energy price dynamics play an important role in the context of climate transition and in terms of the commercial viability of longer-term investments (i.e. retrofitting, renewable energy sources, etc.). The current situation points to the need for more investment in renewable energy sources as economies transition away from fossil fuels, as well as the importance of implementing green reforms.
Equity: COVID-19 has already asymmetrically affected certain demographic groups. There is a risk that higher energy prices will also have disproportionate impacts on lower income groups and older households (energy poverty), which is a particular concern over the winter months.
Policy response: The current rise in energy prices is already impacting economies and there is a need to discuss the impact of higher prices on national budgets. An exchange of views on recent developments and best practice in terms of policy response, including potential areas of common agreement could be advantageous at this stage of budgetary preparations.
More broadly, any decision by governments to intervene to soften energy price movements is partly dependent on how permanent or transitory the shock is expected to be. The type of responses is also impacted by whether the issue is viewed as largely a supply or a demand problem. There are a wide spectrum of policy options and levers open to governments ranging from tackling supply (investment) to demand management (subsides and national taxation measures) as well broader competition and regulatory aspects.
Questions for discussion
1. Assessment – have you taken a view on the extent to which inflation developments, and in particular energy price developments, are temporary/permanent and, if so, what policy insights have you drawn from this?
2. Policy response – what, in your experience, is the appropriate balance between letting current energy market dynamics play out and more active government involvement?
What forms of policy response have you found to be most effective?
3. What are the main macroeconomic and budgetary implications from the recent rise in energy prices?
