A market-design response to the European energy crisis

Due to surges in gas and electricity prices in Europe, many households will struggle to heat their homes this winter. This paper provides high-level guidance on designing a relief policy in a way that optimally trades off equity and efficiency. We argue that, contrary to conventional economic intuitions, an optimal policy may involve directly controlling prices. Because governments do not have perfect information about households' needs, price controls could improve the targeting of relief through screening out the most vulnerable by offering them discounts for reducing consumption. This could be achieved by “threshold price caps" that lower the price of all energy units below some consumption threshold and price units above the threshold at a higher rate.