Thread by @ben_moll

Putin cutting gas to 🇩🇪 and other 🇪🇺 countries raises many important questions:

1. How to best dampen economic costs?

2. Given measures to date, will costs be smaller or larger than estimates from March/April?

3. What does this mean for Russia and the war?

A summary thread:

https://twitter.com/BLSchmitt/status/1540144079975104519

The thread will focus on the German case with (warning!) lots of references in German.

But many of the points should also carry over to other countries, say Italy.

I will also draw heavily on what many smart colleagues have written elsewhere.

Importantly, there remains a large amount of uncertainty, in particular with regard to what Russia will do.

Russia completely shutting down gas deliveries at any moment is a very distinct possibility.

ft.com/content/09ac0a…

1. What policies to best dampen economic costs? What's been done? What should still be done?

I'll differentiate between

a) supply-side policies = replacing Russian gas w other gas

b) demand-side policies = reducing gas demand by households & industry, adjusting supply chains

1a) On supply side, Robert Habeck and @BMWK have implemented some impressive measures in last months, like fast-tracking LNG terminals that should hopefully be operational in Jan 2023.

Thanks to these measures, Germany is much less reliant on Russian gas than before the war.

Thursday's @bnetza analysis suggests that complete cut = about 30% of total consumption (HT @christianbaye13) as compared to ~55% before war.

(Logic: scenario 2.2. --> 10% gas shortage on p8 & add back in 20% demand reduction on p7 = very rough approx.)

bmwk.de/Redaktion/DE/D…

As an aside: on supply side, Germany is actually doing even better than what we thought possible in our "What if?" paper in March.

There we had estimated a shortfall of 30% but *after* taking into account substitution of gas in electricity generation

econtribute.de/RePEc/ajk/ajkp…

1b) On demand side, things look very different: over last three months, little has been done to reduce gas demand.

In fact, the German government even implemented some policies that effectively subsidize gas consumption.

https://twitter.com/JakobSchlandt/status/1538095175242850304?s=20&t=yKFoBsdMQ_24h1G63BUkUw

Fortunately, things are changing. Here's Habeck yesterday declaring "gas is now a scarce resource in Germany." This was after setting in motion the second stage of the national "gas emergency plan".

https://twitter.com/ARD_BaB/status/1539891052370354177?s=20&t=zVuc11M2Q4wLjyXgOnDCXA

Starting in March, many smart colleagues have proposed various policies aimed at reducing gas consumption.

Here are @christianbaye13, @AchimWambach, @GFelbermayr & Martin Hellwig calling for hard financial incentives to lower gas consumption.

In particular, passing higher gas prices onto households but along with compensating based on 2021 consumption.

https://twitter.com/christianbaye13/status/1516842727048376320?s=21&t=rgsVDg7YDEabbFgDbfJVUg

Here's a good interview with @andreasloeschel: "What's missing from the government's relief package: companies and consumers should save a lot more gas."

https://twitter.com/andreasloeschel/status/1514559869646516224?s=20&t=ZzH7Na8K9q26XJX2JPrTLQ

Here are @andreasloeschel @GrimmVeronika and Karen Pittel springerprofessional.de/die-folgen-ein…

.@jsuedekum and @NinaScheer_SPD recently fleshed out in more detail the idea of passing higher gas prices onto households in combination with compensation based on past consumption in the nice form of an "energy saving bonus" (#Energiesparbonus).

https://twitter.com/jsuedekum/status/1539296321575825411

Another overview of policies by @christianbaye13

He reckons that combination of the various policies and market mechanisms would actually yield the 30% drop of gas consumption required to be independent from Russia (see above for source of 30%).

https://twitter.com/christianbaye13/status/1539942136287842310?s=20&t=B-v2O6o_L__HgMcRI4BO0g

The importance of demand-side measures was also an important part of our import stop paper and we suggested some concrete measures, see Section 4 econtribute.de/RePEc/ajk/ajkp…

Though somehow I think most people didn't read that far!

2. Given measures to date, will costs be smaller or larger than estimates from March/April?

For comparison, here's the literature as of April.

Pick your favorite study, say Gemeinschaftsdiagnose, @SVR_Wirtschaft, @bundesbank or perhaps even ours.

https://twitter.com/ben_moll/status/1518164858814013440?s=20&t=QeUYnDzyYaFOb8TyEFfs4w

What if Putin fully cuts gas deliveries now?

How would the costs compare to those from your favorite study?

There are two-offsetting effects and the overall effect is unclear:

First the impressive supply-side measures I discussed above. Also on supply-side, gas storages are now fuller than 3 months ago, roughly 58% compared to 25% (graph from @RobinBrooksIIF)

This obviously lowers the economic costs.

Second, and counteracting these effects: lost time on demand side.

Seasonality of gas demand --> critical time horizon = next winter.

A key principle of economics = substitutability increases with the time horizon. And we have just lost 3 valuable months until the winter.

In those 3 months, no policies aimed at decreasing gas demand were implemented, demand decreased much less / supply chains adjusted much less than they should have, and so on.

Lost time on demand side increases economic costs and counteracts positive developments on supply side.

For those who like equations, look at the constant-elasticity production function in our appendix benjaminmoll.com/RussianGas_app…

Positive supply-side effect: gas shock is smaller

Negative demand-side effect: the elasticity of substitution σ is now lower

The overall effect is unclear.

Aside: the idea that elasticities increase with time is a very old and important one going back to Paul Samuelson and is sometimes called the "Le Chatelier Principle", see for example web.stanford.edu/~milgrom/publi…

Purely based on gut feeling (I do sometimes use that too!) my guess would be: the two effects roughly offset

So re our own study I'd probably still say: rough order of magnitude = up to 3% GDP/GNE loss (rel. to no gas cut)

But obv gut feelings can't replace proper calculations.

Aside: one thing I've always found amazing is that many people think 2 or 3% are tiny numbers. They are not. Instead, they are "substantial but manageable" (with policy).

For example, Habeck recently said "only 2% GDP loss" which I found quite surprising

https://twitter.com/olk_julian/status/1539277357982392330?s=20&t=rUkRBUsa6K0_agdcrkwLJQ

3. What does this mean for Russia and the war?

First, it's important to say that it's still true that less oil and gas revenues are bad for the Russian economy and will ultimately affect Putin's ability to wage war.

The logic hasn't changed:

https://twitter.com/HannoLustig/status/1533353938400989185

Also see this follow-up here:

https://twitter.com/ben_moll/status/1533380109436059649?s=20&t=d8bvreoajnDLbbilHvXjhg

And in particular @sguriev on just how important energy sales are in Russia's government budget (this also includes oil, not just gas, and oil is more important).

project-syndicate.org/commentary/eur…

There's a problem however: gas prices are up by about a factor of 10. So even though gas flows are way down, Gazprom's sales (price*quantity) are still up (relative to a year ago).

At the same time: look at the slope of sales in this graph. It's pointing downwards very sharply.

Why would Putin cut gas sales even though it hurts the Russian economy and his government's budget?

The answer must be: to sow political discord in Europe.

As @CorneliusRoemer says here: "the perfect torture device."

https://twitter.com/CorneliusRoemer/status/1538503386626019328?s=20&t=I4T3bxDbXenPAWXHOZrnFA

So Putin's gamble likely is: even though the costs for Russia may be large, he thinks that in the short run he (personally) can withstand these costs better than Europe.

@GeorgZachmann and Axel Ockenfels explain it well in today's @SPlEGEL

https://twitter.com/GeorgZachmann/status/1540618663568543744?s=20&t=c3pKP4iYtNsNwaIk0INlmQ

.@GeorgZachmann has proposed a number of excellent measures for reacting to the gas cuts:

https://twitter.com/GeorgZachmann/status/1537717860524601344?s=20&t=m19ih6UqdTJHbApJInmofw

In conclusion, Europe needs to show Putin that he has miscalculated in two regards:

1. Costs to Europe are smaller than he thought

2. Costs to Putin are larger than he thought

I'm optimistic that demand-side response that's finally ramping up will achieve goal 1.

If Europe comes together, goal 2 is also in reach.

I'm therefore also optimistic that this entire episode will, in medium- to long-run, actually contribute toward ending the war more quickly

Important p.s.: as a citizen, I still think that calling for complete & immediate gas embargo and/or a tariff back in March was right call.

Precisely because that would have sped up the demand-side adjustment as we also wrote then econtribute.de/RePEc/ajk/ajkp…

https://twitter.com/ben_moll/status/1540683092930637825?s=20&t=NBFBRnHJunKEh2DV24wKmg

And, much more importantly: an embargo or tariff back then would have had a much better chance of affecting Putin's ability to wage war in a decisive fashion.

Finally as @MSchularick says the German government’s plan to “just fill the gas storage to 90%” was perhaps not THAT well thought out after all.

https://twitter.com/mschularick/status/1539872808045629442

In the same spirit, some important additional thoughts from @LukaszRachel

https://twitter.com/lukaszrachel/status/1540762805808365568

And some more thoughts from @elinaribakova, who knows the Russian and Ukranian economies better than almost anyone (and certainly myself) and whom you should all follow:

https://twitter.com/elinaribakova/status/1541104768759877635?s=20&t=jWJH5pjk2V5VBtai8oAnEA

Clarification on demand-side policies: of course the German government didn't just sit around idly (and this should not be the takeaway from my thread).

For example, as @pm_steinberg points out, a gas auction model has been in development bmwk.de/Redaktion/EN/P….

... and there's also an energy-saving ad campaign.

These are great steps, particularly the former.

My points were simply:
- these and other steps could have been taken earlier
- subsidizing industrial energy was/is a mistake

https://twitter.com/andreasloeschel/status/1513422907720052736?s=20&t=SiY2FlOVLjhFDgg-xMqfwg