How should governments respond to energy shocks? A horse-race approach to compare the impacts of energy policies designed to counteract energy shocks

This paper compares the economic impacts of five fiscal policies used during energy crises financed with debt or a combination of debt and windfall taxes. Aggregate and distributional impacts are evaluated using a computable general equilibrium model. The results suggest that production tax reductions and general energy price subsidies are preferable for addressing the aggregate impacts of energy shocks. Tax reductions boost aggregate output at very low inflation costs whilst general price subsidies boost aggregate output most of all the policies at a relatively low inflation cost compared to the other policies. The results also suggest that targeted income subsidies and targeted energy price subsidies are more effective at increasing welfare and reversing the regressive effects of the energy shock. Finally, the results motivate the use of windfall taxation if governments face high-interest rates on debt financing and/ or if households care sufficiently about the provision of public goods. Thus, the optimal policy is likely a mix of supply-side measures (production tax reductions, general price subsidies) and either targeted energy price subsidies or targeted income subsidies financed partially through windfall taxation.