The Distributional and Environmental Dilemma of Energy Price Shocks

Energy price shocks pose complex challenges for climate policy, combining efficiency concerns with distributional tensions. We develop a micro-founded method to estimate the behavioral and environmental effects of energy price changes, combining household expenditure microdata, a structural demand system (EASI), and supply-use tables with production-based GHG inventories. The approach enables consistent attribution of emissions to household demand and captures heterogeneous responses across income groups. Applying the method to a national case study, we simulate price shocks in electricity, heating, and transport fuels. Results reveal asymmetrical and regressive impacts, especially for essential goods with low price elasticity. Emission effects are highly dependent on substitution patterns, with some shocks triggering rebound effects. A lump-sum transfer mitigates welfare losses for electricity and heating, but not for fuels. Comparing predicted and observed aggregate responses during recent crises highlights the limits of elasticity-based instruments in practice. Our findings underscore the need for flexible, context-sensitive compensation mechanisms in carbon pricing design and illustrate a transferable method applicable across national settings.