The Strait of Hormuz Crisis and Energy Subsidization

This study evaluates the impact of rising fossil fuel prices resulting from the 2026 Strait of Hormuz crisis (a war among the United States, Israel, and Iran) on the Japanese economy. It quantifies the effectiveness of government energy subsidy policies by considering the consistency between economic and environmental policies. Using a computable general equilibrium model to simulate a scenario where fossil fuel prices double, the consumer price index (CPI) increases by 3.5%, and households suffer a welfare loss of 11 trillion yen, while greenhouse gas (GHG) emissions decrease by 5.8% (66 million t-CO2). Conversely, if providing a 20% energy subsidy reduces the CPI increase to 1.5%, the household welfare would appear to improve by 116 billion yen. However, the subsidies would worsen environmental outcomes by stimulating fossil fuel consumption, which would otherwise be reduced by price hikes, thereby increasing GHG emissions. This would lead to a deterioration in welfare, accounting for the environmental costs of GHG emissions. Subsidies for electricity and gas, whose markets are less distorted by indirect taxes than fossil fuel markets, are found to be counterproductive, worsening welfare even without considering environmental value.