Transfers or subsidies? Comparing mitigation strategies for energy price shocks in a production network model

Abstract

The dependency on imported essential production inputs poses a threat of abrupt price hikes and shortages, potentially triggered by political events. The energy crisis resulting from the Russian war of aggression is an example. Using a dynamic multi-sector economic model that is calibrated to Germany and incorporates endogenous firm entry and exit, this study investigates whether governments should bolster production via transfers or cost subsidies in the event of a crisis. Findings suggest that subsidizing production costs is more beneficial for economic activity and welfare, provided the energy demand due to the subsidy does not significantly influence the price of the essential production input. If it does, this approach could become exceedingly expensive. In such scenarios, it is economically more efficient to provide lump-sum transfers to firms. The effectiveness of these policies ultimately hinges on their impact on the price of the imported input.