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\title{\vspace{0.8cm} \\
	{\LARGE Lecture 3}\\[1ex]
{\LARGE The Power of Substitution:\\[0.5ex] Germany without Russian Gas}\\
	\noindent \hspace{-0.3cm} \rule{12.8cm}{0.6pt} \vspace{-0.7cm}}
\author{Macroeconomics EC2B1\\[3ex]  Benjamin Moll \\\vspace{0.5cm}}
\institute{London School of Economics, Winter 2024}





\begin{document}

%%%%%%%%%%%%%%%%%%
{
\setbeamertemplate{footline}{} 
\begin{frame}[noframenumbering]
\titlepage
\end{frame}
}



%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{What today's lecture is about}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.86\textwidth]{figures/NS.jpeg}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Background: German primary energy consumption in 2021}
\begin{table}
\begin{tabular}{l r r r r r r r}
\\\toprule
	& Oil& 	Gas &	Coal &	Nuclear&	Renew. &	Rest & 	Total \\\midrule
TWh& 	1077&	905& 	606& 	209&	545&	45&	3387\\[1ex]
\%&	31.8&	26.7&	17.9&	6.2&	16.1&	1.3&	100\\[1ex]\midrule
of which  Russia&	34\% &	\tr{55\%}&	26\%&	0\%&	0\%&0\%	&30\% \\\bottomrule
\end{tabular}
\end{table}
{\small Source: Bachmann et al. (2022a)}
\end{frame}




\begin{frame}{Plan}
\be
\item Background
\bigskip
\item The CES production function: complementarities and substitution in production
\bigskip
\item Back to February 2022 (Russian invasion of Ukraine)
\bigskip
\item After the gas cut-off: how the adjustment happened
\bigskip
\item Political economy of decision making in times of crisis
\bigskip
\item Policies to support households in face of high energy prices
\ee
\end{frame}


\begin{frame}{Background readings: two papers (not examinable)}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.49\textwidth]{figures/whatif.pdf}
\includegraphics[width=.49\textwidth]{figures/brookings.pdf}
\end{center}
\end{frame}



\begin{frame}{Other materials (not examinable)}
\vspace{-2mm}
\bi
\item Marginal Revolution ``Substitutes Are Everywhere" {\tiny \url{https://marginalrevolution.com/marginalrevolution/2023/05/substitutes-are-everywhere-the-great-german-gas-debate-in-retrospect.html}}
\medskip
\item Video available for Brookings presentation\\[-0.5ex]
{\scriptsize\url{https://www.youtube.com/watch?v=-bs5QYr-wO8&t=11295s}}
\medskip
\item Excellent discussions by Jim Hamilton and Tarek Hassan
\medskip
\item Q\&A with lots of great questions and connection to other topics (green transition etc)
\medskip
\item Non-technical summary {\scriptsize\url{https://www.brookings.edu/articles/the-power-of-substitution-the-great-german-gas-debate-in-retrospect/}}
\medskip
\item Podcast (including transcript)\\[-0.5ex] {\scriptsize\url{https://www.brookings.edu/articles/how-did-germany-fare-without-russian-gas/}} 
\medskip
\item Appendix E of Moll-Schularick-Zachmann ``36 concrete cases of substitution and demand reduction"
{\scriptsize\url{https://benjaminmoll.com/GGGD/}}
\ei
\end{frame}




\begin{frame}{Embargo debate after Russian invasion of Ukraine}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.51\textwidth]{figures/millions.png}
\includegraphics[width=.43\textwidth]{figures/brudermueller_infarkt}
\end{center}
\end{frame}



%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Destruction of economy? Worst crisis since end of WWII?}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.75\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/Figures/Figure1.pdf}
\end{center}
Instead: a mini recession followed by stagnation
\end{frame}


%%%%%%%%%%%%%%%%%%%
\begin{frame}{{\large Background: rationales for an energy embargo against Russia}}
\vspace{-3mm}
\bi
\item Oleg Itskhoki: ``Each marginal euro received [by Russia] from energy exports to Europe contributes exactly one euro to the war, simple as that"\\
{\scriptsize \url{https://twitter.com/itskhoki/status/1512508687641763844}}
\bigskip
\item Hanno Lustig: ``Suppose we did a helicopter drop of dollars in Red Square in Moscow. If no one bothers to pick them up, then export curbs are irrelevant. Not a likely outcome."
\bigskip
\item Guriev and Itskhoki ``The Economic Rationale for Oil and Gas Embargo on Putin's Regime" 
{\scriptsize\url{https://sanctions.kse.ua/wp-content/uploads/2022/09/The-Economic-Rationale-for-Oil-and-Gas-Embargo-on-Putins-Regime.pdf}}
\bigskip
\item Guriev op-ed: {\scriptsize \url{https://www.project-syndicate.org/commentary/europe-russia-oil-embargo-needs-immediate-price-cap-by-sergei-guriev-2022-06}}
\bigskip
\item Itskhoki presentation from minute 6 here {\scriptsize \url{https://www.aeaweb.org/webcasts/2023/implications-russia-ukraine}}
\ei
\end{frame}




%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}[plain,noframenumbering]
\renewcommand{\baselinestretch}{1}
\vspace{3cm}
\begin{center}
{\huge The CES production function:}\\[2ex] {\LARGE Complementarities and substitution in production}
\end{center}
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Plan and useful background readings}
\vspace{-3mm}
Introduce a very useful production function: the ``constant elasticity of substitution (CES) production function"
\bi
\medskip
\item this lecture's main application: substitution of natural gas in production
\medskip
\item but to underline generality: introduce with capital and labor $Y = F(K,N)$
\medskip
\item many other applications
\medskip
\item example: skill-biased technical change \& skill premium $Y = F(N_s,N_u)$
\medskip
\item another possibility: CES utility function $\Rightarrow$ substitution in consumption
\ei
\bigskip
Useful background readings
{\setstretch{0.5}
\bi
\medskip
\item Your EC1A1 lecture notes on producer theory
\medskip
\item Chapter 2 here\\{\tiny \url{https://web2.econ.ku.dk/okocg/MAT-OEK/Mak\%C3\%98k2/Mak\%C3\%98k2-2015/Forel\%C3\%A6sninger/Ch1-3-M2-2015-3.pdf}}
\medskip
\item Appendix A.2 here {\scriptsize \url{https://benjaminmoll.com/RussianGas_Appendix/}}
\ei}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Some production functions you should already know}
Technology: output $Y = F(K,N)$ is produced using capital $K$ and labor $N$ 
\bigskip
\be
\item Cobb-Douglas
$$Y = A K^\alpha N^{1-\alpha}, \quad A>0, \ 0<\alpha< 1 $$
\item Perfect substitutes
$$Y = A_K K + A_N N, \quad A_K,A_N>0 $$
\item Perfect complements, fixed proportions, or ``Leontief"
$$Y = \min\{B_K K, B_N N \}, \quad B_K,B_N>0 $$
\ee
\end{frame}



\begin{frame}{The CES Production Function}
\vspace{-3mm}
$$Y = F(K,N) = \left(\alpha^{\frac{1}{\sigma}} (A_K K)^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} (A_N N)^\frac{\sigma-1}{\sigma} \right)^\frac{\sigma}{\sigma-1}$$
\bi
\item The CES production function is a generalization of the three production functions on previous slide
\bigskip
\item Key parameters
\bi
\medskip
\item $\sigma$: elasticity of substitution, here between $K$ and $N$
\medskip
\item $\alpha$: share parameter
\medskip
\item $A_K,A_N$: capital- and labor productivity (factor-specific productivity)
\ei
\bigskip
\item Will often see it written slightly differently, e.g.
$$Y = \left(\theta_K (A_K K)^\rho +  \theta_N (A_N N)^\rho \right)^{1/\rho}$$
that's the same thing, e.g. $\sigma = 1/(1-\rho)$
\ei
\end{frame}


\begin{frame}{Special cases of the CES production function}
\vspace{-8mm}
$$Y = \left(\alpha^{\frac{1}{\sigma}} (A_K K)^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} (A_N N)^\frac{\sigma-1}{\sigma} \right)^\frac{\sigma}{\sigma-1}, \quad \sigma = \mbox{elasticity of substitution}$$
\vspace{-3mm}
\be
\item Case $\sigma = 1$: Cobb-Douglas
$$Y = \left(\frac{A_K K}{\alpha}\right)^\alpha \left(\frac{A_N N}{1-\alpha}\right)^{1-\alpha} = A K^\alpha N^{1-\alpha} $$
\item Case $\sigma \rightarrow \infty$: perfect substitutes
$$Y = A_K K + A_N N$$
\item Case $\sigma = 0$: perfect complements, fixed proportions, or ``Leontief"
$$Y = \min\left\{\frac{A_K K}{\alpha},\frac{A_N N}{1-\alpha} \right\} $$
\ee
\vspace{-3mm}
Derivations (see supplement)
\bi
\medskip
\item proof of case 2 relatively simple: as $\sigma \rightarrow \infty$, $\frac{1}{\sigma} \rightarrow 0$, $\frac{\sigma-1}{\sigma} \rightarrow 1$, $\frac{\sigma}{\sigma-1} \rightarrow 1$
\medskip
\item proof of cases 1 and 3: more complicated, need to apply l'Hopital's rule
\ei
\end{frame}


\begin{frame}{Isoquants of the CES production function}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.8\textwidth]{figures/13.eps}
\end{center}
\end{frame}




\begin{frame}{CES production function: marginal products and MRT}
\vspace{-5mm}
$$Y = \left(\alpha^{\frac{1}{\sigma}} (A_K K)^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} (A_N N)^\frac{\sigma-1}{\sigma} \right)^\frac{\sigma}{\sigma-1}$$
\vspace{-3mm}
\bi
\item Marginal product of capital
$$
\frac{\partial F(K,N)}{\partial K} = \left(\alpha^{\frac{1}{\sigma}} (A_K K)^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} (A_N N)^\frac{\sigma-1}{\sigma} \right)^{\frac{\sigma}{\sigma-1} - 1}\alpha^{\frac{1}{\sigma}} A_K^\frac{\sigma-1}{\sigma} K^{-\frac{1}{\sigma}}$$
\item Marginal product of labor
$$\frac{\partial F(K,N)}{\partial N} = \left(\alpha^{\frac{1}{\sigma}} (A_K K)^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} (A_N N)^\frac{\sigma-1}{\sigma} \right)^{\frac{\sigma}{\sigma-1} - 1}(1-\alpha)^{\frac{1}{\sigma}} A_N^\frac{\sigma-1}{\sigma} N^{-\frac{1}{\sigma}}$$
\item Marginal rate of transformation
$$\Rightarrow \frac{\partial F(K,N)/\partial K}{\partial F(K,N)/\partial N} = \left(\frac{\alpha}{1-\alpha}\right)^{1/\sigma} \left(\frac{A_K}{A_N} \right)^\frac{\sigma-1}{\sigma} \left(\frac{K}{N}\right)^{-1/\sigma} $$
\ei
\end{frame}


\begin{frame}{Elasticity of substitution: how input mix responds to prices}
\vspace{-2mm}
\bi
\item Consider profit maximizing firm: $\max_{K,N} \ F(K,N) - WN - R K$ where $R$ and $W$ = prices of capital and labor. Optimality:
$$\frac{\partial F(K,N)}{\partial K} = R, \qquad \frac{\partial F(K,N)}{\partial N} = W \quad \Rightarrow \quad \frac{\partial F(K,N)/\partial K}{\partial F(K,N)/\partial N} = \frac{R}{W}  $$
\item Using expression from previous slide
$$\left(\frac{\alpha}{1-\alpha}\right)^{1/\sigma} \left(\frac{A_K}{A_N} \right)^\frac{\sigma-1}{\sigma} \left(\frac{K}{N}\right)^{-1/\sigma} = \frac{R}{W} \quad \Rightarrow \quad \tr{\frac{K}{N} = \textrm{constant} \times \left(\frac{R}{W}\right)^{-\sigma}}$$
\item Response of input mix $K/N$ to factor prices $R/W$ depends on $\sigma$
\bi
\smallskip
\item Leontief $\sigma = 0$: input mix does not respond to prices at all
\smallskip
\item Perfect substitutes $\sigma \rightarrow \infty$: input mix responds extremely strongly
\smallskip
\item In general
$$\frac{d \log (K/N)}{d \log (R/W)} = - \sigma $$
\ei
\ei
\end{frame}




\begin{frame}{{\large Le Chatelier principle: long run elasticity $>$ short run elasticity}}
\begin{center}
\includegraphics[width=.49\textwidth]{figures/lechatelier_isoquant}\includegraphics[width=.49\textwidth]{figures/lechatelier_milgrom}
\end{center}
\end{frame}


\begin{frame}{Micro vs macro elasticities}
\bi
\item \textbf{\tr{Micro:}} substitution \tr{within} a given production process
\bi
\medskip
\item often limited, production close to Leontief
\ei
\bigskip
\item \textbf{\tr{Macro:}} substitution not just \tr{within} production processes / firms  but also \tr{across} production processes / firms (extensive margin)
\bi
\medskip
\item often substantial, especially with time (le Chatelier)
\ei
\bigskip
\item In general: \tr{macro elasticity $>$ micro elasticity}
\ei
\end{frame}


\begin{frame}{Application to gas crisis: how much does production fall when a critical input falls?}
\vspace{-4mm}
$$ Y=\left[ \alpha^{\frac{1}{\sigma}} G^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} X^\frac{\sigma-1}{\sigma} \right]^\frac{\sigma}{\sigma-1}$$
where $G$ = gas, $X$ = other factors, e.g. $X = \tilde{F}(K,N)$
\bi
\medskip
\item Consider drop in $G$, e.g. $\Delta \log G = -20\%$. How much does $Y$ fall?
\medskip
\item Gas has small expenditure share $\alpha$ but also small elasticity $\sigma$
\bigskip
\pause
\item Useful benchmarks:
\be
\medskip
\item Cobb-Douglas $\sigma = 1$: $Y = G^\alpha X^{1-\alpha}$ with $\alpha = 0.01$
$$\Delta \log Y = \alpha \Delta \log G = 0.01 \times (-20\%) = -0.2\% $$
\item Leontief $\sigma = 0$: $Y = \min\{G/\alpha,X/(1-\alpha) \}$
$$\Delta \log Y = \Delta \log G = -20\% = \textrm{catastrophe} $$
\ee
\ei
\end{frame}


\begin{frame}{Output losses for different elasticities of substitution}
\vspace{-3mm}
\begin{figure}
	\includegraphics[width=.6\linewidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/Figures_backup/Figure3.eps}
\end{figure}
\bi
\item \tb{Leontief $\sigma=0$} $\Rightarrow$ production drops one-for-one with gas usage $= \tb{20\%}$
\smallskip
\item Even with \tr{$\sigma=0.05$}, output losses much smaller $= \tr{2.7\%}$ (almost $10x$)
\ei
\end{frame}



%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{The worry: ``cascading effects" along supply chain}
\vspace{-4mm}
\begin{center}
\includegraphics[width= .9\textwidth]{figures/Network.png}
\end{center}
\bi
\item Literature on production networks, beyond scope of this course
\medskip
\item But same key prediction: Leontief $\Rightarrow$ total production drops one-for-one with gas usage
\ei
\end{frame}








%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}[plain,noframenumbering]
\renewcommand{\baselinestretch}{1}
\vspace{3.5cm}
\begin{center}
{\Huge Back to February 2022}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{What things looked like in February 2022}
\begin{table}
\begin{tabular}{l r r r r r r r}
\\\toprule
	& Oil& 	Gas &	Coal &	Nuclear&	Renew. &	Rest & 	Total \\\midrule
TWh& 	1077&	905& 	606& 	209&	545&	45&	3387\\[1ex]
\%&	31.8&	26.7&	17.9&	6.2&	16.1&	1.3&	100\\[1ex]\midrule
of which  Russia&	34\% &	\tr{55\%}&	26\%&	0\%&	0\%&0\%	&30\% \\\bottomrule
\end{tabular}
\end{table}
\pause
\bigskip
Oil and coal have \textbf{global market} (+ a strategic reserve)\\
\bigskip
Gas trickier due to pipeline network, limited LNG supplies \tr{$\Rightarrow$ focus on gas} \\
\bigskip
Consumption of gas (also = imports): $\approx 1\%$ of GNE
\bi
\medskip
\item small number but \tr{energy = critical input} $\Rightarrow$ amplification important
\ei
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{Important: strong seasonality of gas demand}
%\vspace{-3mm}
%\begin{center}
%\includegraphics[width=.8\textwidth]{figures/gas_consumption_EN.png}
%\end{center}
%\end{frame}


\begin{frame}{Objectives and results of March 2022 ``what if?" paper}
\vspace{-3mm}
Assess consequences for Germany of cut-off from Russian energy imports
\bi
\medskip
\item either embargo by Germany/EU
\medskip
\item \tr{or stop of deliveries by Russia}
\ei
\bigskip
\pause
Get sense of rough magnitudes of losses relative to ``do nothing'' baseline\\
\be
\medskip
\item Small GDP decline, say 0.5-1\%, perhaps not even a recession?
\medskip
\item Like Covid = 4.5\% decline in German GDP?
\medskip
\item Like Spain or Portugal during Euro crisis (5.1\% \& 7\%)?
\medskip
\item ``Mass unemployment and poverty'' so perhaps like Great Depression?
\ee
\bigskip
\pause
Our answer at the time: \tr{GDP decline up to 3\%} (``substantial but manageable")
\bi
\smallskip
\item Key mechanism: \tr{substitution} of gas and gas-intensive inputs
\smallskip
\item Based on model calculations of type we just discussed + relevant empirical estimates (e.g. of elasticities of substitutions)
\ei
\end{frame}



\begin{frame}{Simplest Model}
$$ Y=\left[ \alpha^{\frac{1}{\sigma}} Gas^\frac{\sigma-1}{\sigma} +  (1-\alpha)^{\frac{1}{\sigma}} F(K,L)^\frac{\sigma-1}{\sigma} \right]^\frac{\sigma}{\sigma-1}$$
\bi
\item Gas has small expenditure share, but substitution elasticity might be small
\bigskip
\item Empirical estimates: \textbf{short run} ($<$12 months) demand elasticities\\ 0.4 (Industry) and 0.2 (households)
\bigskip
\item We assumed an elasticity of  $0.1$ and a  $-30$\% gas shock
\bigskip
\item Also simulations with richer, more complicated model (Baqaee-Farhi)
\bi
\medskip
\item production networks, supply chains, cascading effects
\medskip
\item international trade
\ei
\end{itemize}	
\end{frame}



\begin{frame}{Table with main results of March 2022 ``what if?" paper}
\vspace{-10mm}
	\begin{table}
		\begin{tabular}{l p{0.15\linewidth} p{0.15\linewidth} p{0.18\linewidth} p{0.18\linewidth}}
&&&\\\toprule& Baqaee-Farhi&		Baqaee-Farhi&	Simplest model&	Simplest model\\
& {\small suff. statistic}  & simulation 	& 10\% energy $\downarrow$&	30\% gas $\downarrow$\\[1ex]\midrule
\midrule \\[-1.5ex]
GNE Loss, in \% & $< 1$  &	$<0.3$&	1.5&	2.3\\[1ex]
As \% of GDP  & $<1$ &	$<0.3$&	1.3&	2.2\\[1ex]
Per capita &	\euro 400& \euro 100&	\euro 600&	\euro 900\\[1ex]\bottomrule	
\end{tabular}
\end{table}
\bi
\item All models use conservative elasticity estimates
\medskip
\item Simplest model (= production fn) abstracts from trade 
\medskip
\item The cost statements are in terms of GNE
\medskip
\item Some mechanisms left out $\Rightarrow$ round up headline to 3\% (``safety margin'')
\ei
\end{frame}


\begin{frame}{Reception by German government}
Chancellor Scholz on TV, responding to ``economists don't predict doom''
\bi
\medskip
\item ``But they get it wrong! And it's honestly \tr{irresponsible to calculate around with some mathematical models} that then don't really work.''
\medskip
\item ``I don’t know absolutely anyone in business who doesn't know for sure that these would be the consequences.''
\ei
\bigskip
Head of chancellery Wolfgang Schmidt during televised panel
\bi
\medskip
\item ``The second thing is, what they call elasticity, the question whether you can substitute
or whether you cannot substitute gas, oil, and coal.''
\medskip
\item \tr{``And they always said in that model: `Yeah there is elasticity, it is not zero.' But that is not true.''}
\ei
\bigskip
Transcripts: {\scriptsize \url{https://benjaminmoll.com/Scholz/}} and {\scriptsize \url{https://benjaminmoll.com/Schmidt/}}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{What happened next?}
Soon after: \textbf{\tr{Cut-off happens}} because Russia weaponizes gas supplies
\bi
\bigskip
\item June 2022: drastically cuts supplies, particularly via Nord Stream
\bigskip
\item August 2022: completely halt Nord Stream flows (destroyed 4 weeks later)
\ei
\end{frame}



%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{What happened next? August 2022}
\pause
\vspace{-4mm}
\begin{center}
\includegraphics[width=.92\textwidth]{figures/fake_leak.png}
\end{center}
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{What happened next? September 2022}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.86\textwidth]{figures/NS.jpeg}
\end{center}
\end{frame}




%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}[plain,noframenumbering]
\renewcommand{\baselinestretch}{1}
\vspace{3.2cm}
\begin{center}
{\huge How the Adjustment Happened}
\end{center}
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Destruction of economy? Worst crisis since end of WWII?}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.75\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/Figures/Figure1.pdf}
\end{center}
Instead: a mini recession followed by stagnation
\end{frame}

%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Large adjustments on both demand- and supply side}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.75\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure4.pdf}
\includegraphics[width=.75\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/Slides_brookings/figure4_note}
\end{center}
%{\scriptsize Notes: The figure compares German natural gas imports, consumption, and storage change for the period July 2022 - March 2023, to the corresponding average from 2019 to 2021 using data from Eurostat (database code nrg\_ti\_gasm), McWilliams and Zachmann (2023), and AGSI. On the supply side, we take into account not only direct imports to Germany but also indirect imports via third countries as well as re-exports within Europe. More details, including on sources, are in appendix B.}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Large demand reduction by industry and households}
\begin{center}
\includegraphics[width=.9\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/Slides_brookings/table2}
\end{center}
\end{frame}


%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{{\large Industrial production in Germany and Europe looks nothing like Leontief}}
%\vspace{-4mm}
Recall: Leontief $\Rightarrow$ should have seen 20-30\% drop in industrial production
\bigskip
\begin{center}
\includegraphics[width=.5\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure5_a.pdf}\includegraphics[width=.5\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure5_b.pdf}
\end{center}
\end{frame}



%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{{\large Decoupling: large cuts in energy-intensive sectors but not rest \\ = polar opposite of ``cascading effects"}}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.8\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure6.pdf}
\end{center}
\end{frame}

%
%%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{}
%%\vspace{-4mm}
%\begin{center}
%\includegraphics[width=\textwidth]{../figures/figure7.pdf}
%\end{center}
%\end{frame}


%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Substitution of gas-intensive products via imports}
\vspace{-4mm}
\begin{center}
\includegraphics[width=.5\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure8.pdf}
\end{center}
\vspace{-2mm}
BASF's ammonia production (= very gas-intensive): when gas prices $\uparrow$
\bi
\smallskip
\item drastically cut ammonia production in Luwigshafen, Germany
\smallskip
\item But BASF has plant in U.S. $\Rightarrow$ produce ammonia there, ship it to Germany
\ei
\medskip
Substitution via imports can happen even within same company \\
\medskip
Bad for German ammonia production but kills cascading effects

\end{frame}


%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}[plain,noframenumbering]
%\renewcommand{\baselinestretch}{1}
%\vspace{3.5cm}
%\begin{center}
%{\Huge Households}
%\end{center}
%\end{frame}
%
%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{Gas consumption by households: large demand reduction}
%\vspace{-4mm}
%\begin{center}
%\includegraphics[width=.85\textwidth]{figures/households.pdf}
%\end{center}
%\end{frame}
%
%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{... true even when controlling for temperature}
%\vspace{-4mm}
%\begin{center}
%\includegraphics[width=.9\textwidth]{figures/households_temperature.png}
%\end{center}
%\end{frame}
%


%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{Prices (Dutch TTF Gas Futures)}
%\begin{center}
%\includegraphics[width=\textwidth]{figures/TTF.png}
%\end{center}
%Source: {\tiny \url{https://www.theice.com/products/27996665/Dutch-TTF-Gas-Futures/data?marketId=5460494&span=2}}
%\end{frame}
%





%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}[plain,noframenumbering]
\renewcommand{\baselinestretch}{1}
\vspace{3cm}
\begin{center}
{\huge Political economy of \\[1ex] decision making in times of crisis}
\end{center}
\end{frame}




%When the discussion about Germany’s vulnerabilities began after the Russian invasion,
%policy-makers did not turn to academics, but to business leaders and their associations for
%advice. The key interlocutors were representatives of the most affected industries such as the
%energy and chemicals sectors, refineries and other industrial companies. This was primarily due
%to policy-makers’ concern to understand the practical implications of a cut-off from Russian gas
%and what this would mean for operations “on the ground.”

%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Two political problems with lessons for future crises}
\vspace{-3mm}
1. Policymakers turned to business leaders \& their associations for advice
\bi
\smallskip
\item ``expertise on the ground" but also clear incentive to talk up dependence
\smallskip
\item striking divergence: claimed dependence vs observed substitution (BASF)
\ei
\medskip
2. Strategic use of special-interest-financed think-tanks to increase uncertainty
\vspace{-2mm}
\begin{center}
\includegraphics[width=.5\textwidth]{/Users/mollb1/Dropbox/Papers/RussianGas_hindsight/figures/figure13.pdf}
\end{center}
\vspace{-3mm}
Head of Chancellery Econ Division: {\footnotesize ``We will never ever be able to determine whether this has a 2\% or 10\% GDP impact. We are simply trying to take the pragmatic middle course."}
\end{frame}





%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}[plain,noframenumbering]
\renewcommand{\baselinestretch}{1}
\vspace{3.5cm}
\begin{center}
{\Huge Policies to Support Households}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Good and bad policies to support households}
\bi
\item Absolutely crucial to support households, especially economically weaker ones, in the face of rising gas prices
\bigskip
\item Should be done by means of transfers that are not directly tied to gas consumption and that preserve incentives for reducing gas demand
\bigskip
\item Good policy: German ``gas cost break" (commission incl Bayer \& Pittel)
\bi
\medskip
\item importantly, not price subsidy / cap but lump-sum transfers
\medskip
\item compensation based on historical consumption = Bayer's idea featured in ``what if" and ``how it can be done" papers
\medskip
\item {\scriptsize \url{https://www.bmwk.de/Redaktion/DE/Dossier/Gas-Kommission/zwischenbericht-expert-innen-kommission-gas-warme.html}}
\medskip
\item {\scriptsize \url{https://www.bmwk.de/Redaktion/DE/Publikationen/Energie/abschlussbericht.html}}
\ei
\ei
\end{frame}





%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Gas commission: lump sum, not price subsidy or cap}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/bill0.eps}
\end{center}
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Gas commission: lump sum, not price subsidy or cap}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/bill1.eps}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Price cap: diminished incentives for reducing consumption}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/bill_cap.eps}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Useful momentarily: as \% of previous consumption}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/bill_cap2.eps}
\end{center}
\end{frame}

%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Gas commission: lump sum, not price subsidy or cap}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/bill_LS.eps}
\end{center}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
\begin{frame}{Target income effect but leave substitution effect intact}
\vspace{-3mm}
\begin{center}
\includegraphics[width=.7\textwidth]{figures/income_substitution.jpeg}
\end{center}
\vspace{-3mm}
{\scriptsize \url{https://twitter.com/maxgoedl/status/1583350372110045185?s=20&t=mNKsTyfX2KRLfpj-Fxrz1g}}
\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{For comparison: price cap up to 80\%}
%\vspace{-3mm}
%\begin{center}
%\includegraphics[width=.7\textwidth]{figures/bill_cap80.eps}
%\end{center}
%\end{frame}


%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{Reason not to target by income}
%\vspace{-3mm}
%\begin{center}
%\includegraphics[width=.8\textwidth]{figures/gas_usage_by_income.jpeg}
%\end{center}
%Source: EVS, {\scriptsize\url{https://twitter.com/LionHirth/status/1582618195063492608}}
%\end{frame}
%
%
%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%
%\begin{frame}{Challenge: average vs marginal prices}
%\vspace{-3mm}
%\begin{center}
%\includegraphics[width=.7\textwidth]{figures/ito.png}
%\end{center}
%\bi
%\item But \tr{information campaign} could change this (e.g. Kahn and Wolak, 2013)
%\ei
%\end{frame}




\begin{frame}{Key Takeaways}
\vspace{-3mm}
Germany blunted Putin's energy weapon using two margins of adjustment:
\bi
\medskip
\item \tr{Supply side:} gas imports from 3rd countries $\uparrow$ (insurance through trade)
\medskip
\item \tr{Demand side:}  demand $\downarrow$ 20\% driven by industry (26\%), households (17\%)
\ei
\bigskip
Key lesson: \tr{the power of substitution}
\bi
\medskip
\item A bit of substitution goes a long way: $\sigma = 0.05$ very different from $\sigma = 0$
\medskip
\item Large number of examples how this works in practice -- see appendix
\ei
\bigskip
\tr{Decoupling} from energy-intensive industries rather than cascading effects\\
\bigskip
In retrospect, even immediate gas import stop (embargo) was feasible \\
\bigskip
Not implementing sanctions against Russia sooner and more decisively
\\ = major missed opportunity to help avert enormous human suffering in Ukraine
\end{frame}





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\end{document}

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