Opinions

Greenflation: Lowest Income Groups Hit The Hardest By European Energy Crisis

The EU's push for the transition to a green circular economy is coming at a cost for the weakest in society. Too optimistic prospects of renewable energy sources combined with higher energy demand have led to exponentially rising energy prices that will hit low income groups the hardest.

Starting from September onwards energy analysts warned for potential energy shortages due to lower than expected generation of energy by windmill parks at sea. Especially the United Kingdom, Denmark and Spain were forced to ramp-up coal and gas-fired electricity plants were called in to make up the shortfall from wind. This has caused prices for coal and gas to rise to extreme highs in recent months as the shortage lasted and widened. However, due to the sudden need to generate energy using fossil fuels the prices for carbon allowances went through the roof as well causing even higher energy prices. Operating costs for power plants have gone up tremendously to unseen levels in decades. Even though this is exactly the function of the EU emission cap-and-trade system, this has further increased prices in the already hot energy markets.

Figure 1 – Energy Prices in the UK remain elevated

Governments Should Incorporate Energy Reliability In Their Green Strategy

Many governments in Europe have decided to limit the burden on households by covering part of the costs. This is the first time where the necessary push for green energy has caused side-effects burdening individuals and governments with rising bills. The end is not in sight, but governments should be aware of the necessity to provide stable and reliable energy systems in its green transition strategy. In this way, lowest income groups who spend most of their income will get squeezed out. Consumer authorities expects that energy prices for households will rise over 50 percent on average this year, an unmanageable rise in cost for lowest income groups.

Lowest Income Groups Are Hit The Hardest From Current Inflation

In the United States the price of food rose by 6.1 percent compared to a year ago, while the average energy price jumped by 33.3 percent in November. These price increases do not affect all households in the same way because the consumption baskets of high-income and low-income households differ. Because of variation in the composition of consumption bundles, a Wharton University study finds that higher-income households had smaller percentage increases in their total expenditure. This is because higher-income households spent relatively more on services, which experienced the smallest price increases. On the other hand, lower-income households spent relatively more on energy whose prices had large increases.

The same is the case in Europe where energy prices are elevated as well and will trickle down into food prices as manufacturers face rising costs and will try to use this correction to also improve their own profit margins. Therefore, even though energy prices have been dropping due to the increased energy supply from Russia and other parts of the world and the still relatively soft winter, the damage is already done and will most likely become visible in supermarkets as well in 2022. Analysts expect inflation to come down as government expenditures relating to corona have come down, while central banks have been hinting towards several interest rate hikes and tapering efforts to soften the current inflationary pressure

Eurozone inflation hits new record as energy and food ...
Figure 2 – Inflation in the Eurozone on a record high

It is hard to assess and quantify which income group is hurt the most by rising inflation. However, a fact is that stock markets have seen double digit percentage increases, partly due to excessive quantitative easing programs by central banks. The highest income group benefits the most from rising stock markets as they simply have the most disposable income. That is the same reason why poorer people feel a much heftier burden of rising inflation even if their purchasing power would be affected by the same percentage. People with the lowest income are the socioeconomic group that find it hardest to purchase a home, and real estate seems to be one of the best inflation hedges. On top of that, low income groups often have much lower savings that means that inflation surges will directly impact their consumption abilities.

The Worst Has Yet To Come

Within this topic the potential harsh side effects of rising interest rates and quantitative tapering remain out of the discussion, while these factors could mean that economic growth could drop significantly as well. While the aging of the baby-boom generation will put increased pressure on government finances that have to rely on a lower amount of workers for their tax income, a major problem that slowly will dampen the economic prosperity seen in the last decade.

Meanwhile also other commodities have seen major price spikes last year, like aluminium, copper and oil. All these assets face investment shortages, while gas and oil explorations have been going down due to lower investment in fossil fuels. The push for alternative energy sources has come at a cost of energy security which next to the surge of demand has pushed prices higher in almost all physical assets. It has to be seen whether more hawkish central bank attitudes will dampen these price surges or whether 2022 will see lasting inflation.

Bibliography

  1. https://www.catalyst-commercial.co.uk/works/dec-2021-energy-market-brief-2/
  2. https://budgetmodel.wharton.upenn.edu/issues/2021/12/15/consumption-under-inflation-costs
  3. https://www.ft.com/content/14d1e3f5-5131-4f0f-8e57-228810898b8f

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