ECB | Energy prices and private consumption: what are the channels?

1 Introduction

The recent increase in energy prices raises the question of the extent to which households will reduce their consumption in response. With the global economy in the process of recovering from the coronavirus (COVID-19) pandemic, the prices of many commodities – including oil and gas – have soared over the last year or so. Since demand for energy is inelastic in the short run, those large price increases imply significant declines in households’ purchasing power, which will need to be absorbed through (i) reduced consumption of non-energy goods and services, (ii) a reduction in savings or (iii) an increase in income. This article assesses the extent to which those three margins are playing a role in the transmission of higher energy prices to aggregate consumption. In addition, it analyses the distributional impact of higher energy prices, as the effect on individual households tends to vary considerably. Since the distributional impact of such price rises has the potential to be very significant, that may warrant a separate policy response independently of the macroeconomic implications of those developments.

The rise in energy prices should be seen in the context of an exceptional economic recovery, but other factors are also playing a role. While the impact that energy prices have on consumption has been studied before, the recovery following the COVID-19 crisis is atypical from a historical perspective. Thus far, it has been characterised by a surge in global demand for durable and non-durable consumer goods, leading to unprecedented bottlenecks in production and trade, with households having accumulated record levels of savings in the course of the pandemic.^[1] Moreover, the supply of energy has been hampered by a lag in the production of oil, as well as geopolitical tensions – especially Russia’s recent invasion of Ukraine – and technical disruptions affecting the provision of natural gas to European countries.^[2] It is important to account for these confounding factors in order to understand the aggregate impact that higher energy prices will have on private consumption and formulate an appropriate policy response.

This article presents new evidence for the euro area and is structured as follows. Section 2 outlines relevant existing literature. Section 3 presents new empirical evidence from both an aggregate and a disaggregated perspective. The aggregate perspective focuses on identifying the source of energy price fluctuation, while the disaggregated perspective focuses on distributional implications beyond the aggregate impact. Importantly, in order to provide a timely assessment of the macroeconomic and distributional implications of large changes in energy prices, the aggregate and disaggregated analyses are both based on survey data. Section 4 concludes and identifies a number of policy implications

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Authors:

• Niccolò Battistini
• Virginia Di Nino
• Maarten Dossche
• Aleksandra Kolndrekaj

Compliments of the European Central Bank.