Lessons Learned from the German Double Whammy: The Importance of Price Incentives and Targeted Compensation for the Design of Energy and Climate Policy

Russia’s invasion of Ukraine has led to unprecedented geopolitical and global economic challenges, including a severe shortfall in energy supply and a substantial increase in energy prices. Even before that crisis, many governments were aiming to phase out fossil energy. Here, we focus on the importance of demand-side policies, using the German double whammy as a case study. This was a large-scale policy package to incentivize energy savings and compensate households using a so-called price brake. We explain that the natural gas “price brake” was in fact not a price brake but, quite the contrary, maintained price incentives in combination with financial lump-sum transfers to natural gas consumers. We present an assessment of key features and distributional consequences of the “price brake” and then discuss the lessons learned for future policy design in Germany and beyond: First, maintaining strong price incentives for reducing demand can be politically feasible. Second, hardship can be avoided at the least economic cost if transfers are targeted to lower-income consumers, which is not the case in Germany.