Name: Why do Inefficient Policies Persist?
Start: 2024-05-07T11:00:00+01:00
End: 2024-05-07T12:30:00+01:00
Location: 225 Central House, UCL

Why do Inefficient Policies Persist? Evidence from Price Freezes in Energy Markets in Brazil
About this Event

Governments around the world have relied on price freezes of salient commodities as a strategy for managing inflation expectations. In the case of Brazil, the government has maintained a wholesale gasoline price freeze since 2002 by controlling the board of Petrobras, the country’s major oil company. Often, price freezes also become de-facto energy subsidies that can compromise climate mitigation goals.

Exploiting an unexpected announcement to end a wholesale gasoline price freeze in Brazil, we study the welfare effects, the distributional impacts, and the political economy determinants of the persistence of wholesale gasoline price freezes.

With an event study that relies on theoretical finance models and data-driven methods (synthetic controls and machine learning) to recover counterfactual expected stock returns for Petrobras, our central estimates of the causal effect of the announcement to end the price freeze imply an increase of 7% of total firm value. Importantly, the price freeze appears to have been ineffective in controlling inflation expectations and is likely welfare reducing, with costs outweighing benefits. Its high gross costs are driven mostly by the underlying cost of capital to secure the price freeze, which we calculate to be 40%. In order for the price freeze to be welfare improving, benefits from eliminating price volatility would have to be valued at least at R$0.14 per liter of gasoline.

Other less costly policy instruments that do not remove the volatility in prices, such as gasoline subsidies or cash transfers, could transfer the exact same amount of money to individuals, allowing them to adjust against gasoline price volatility. However, we provide suggestive evidence that politicians are unlikely to engage in a policy reform that eliminates the price freeze. In fact, we show that under these other alternative instruments, the politician would likely lose re-election.

Taken together, our findings are consistent with the existence of credit constraints that limit the ability of individuals to handle price volatility, particularly for lower income individuals, and individuals’ overestimation of the costs of volatility and resulting benefits of transfers of salient commodities.