Can falling natural gas prices help to prevent a recession?

Published on: 5 January 2023

Current issues related to economy, (responsible) investment, pension and income: every week an APG expert gives a clear answer to the question of the week. This time: chief economist Thijs Knaap on whether the falling energy prices are helping to prevent the impending recession.


The price of natural gas in Europe has fallen sharply recently. While it was still 135 euros per megawatt hour in mid-December, on Wednesday the gas price fell below 70 euros. The price of natural gas has not been this low since February 2022. Assuming that rising energy prices are an important part of the current inflation, the question is to what extent falling energy prices carry over into a reduction in the price level. And - perhaps more importantly - whether falling energy prices can prevent the impending recession. A recession would mean that the Dutch economy had two consecutive quarters of negative economic growth. The third quarter of 2022 saw a small contraction, and for the fourth quarter that seems very likely as well. This makes a recession seem all but inevitable. This is true for a third of the world economy, incidentally, the International Monetary Fund (IMF) recently warned. 



It is beyond dispute that the falling energy price will ensure that inflation remains limited, according to Knaap. “The question is to what extent and whether it is enough. In November, inflation in the euro zone was 10 percent. Of that, energy accounted for almost 4 percent. If energy prices were to fall year after year, you could eliminate almost half of inflation. The only problem is that inflation would still be 5 percent.” That percentage is mainly caused by the price increase of food (3 percent), and the rest by that of services and goods. “If you look at the price increases of energy and food that we had before 2008, when inflation was 2 percent (the target rate used by the European Central Bank, ed.), and add that to the current inflation rate for services and goods, you arrive at a total inflation rate of 4 percent. That means that not only energy and food have become much more expensive, but also services and goods. Why is that? Partly because of energy, because you need gas to grow tulips, for example, but also partly because of wages. And those are harder to limit than energy prices.” In short, the falling energy price is keeping inflation down. Yet inflation is still so high that the European Central Bank (ECB) is not yet inclined to stop its interest rate hikes.


With that tightening policy, the ECB is making life more expensive in the EU. This is because borrowing money is costing businesses and consumers more money at higher interest rates. But inflation also leads to loss of purchasing power in a direct sense, Knaap explains. “If you spend 100 euros more on energy, you have 100 euros less to spend in the supermarket. If the price of energy drops, purchasing power can partially recover. The dynamics that occur in a recession, where consumers spend less, companies get into trouble as a result and have to lay off employees, which causes people to spend even less, are slowed down when energy prices fall. And that does make a difference to the severity of the recession, since the price increases were substantial in the past year.” However, Knaap believes that falling energy prices will not be enough to avert the recession, as energy prices no longer sufficiently account for inflation.

Falling energy prices are good news, but not good enough


A recession can be a self-reinforcing process that gets caught up in a turbo, so to speak, as happened during the 2008 financial crisis. “That dynamic is now happening to some degree, but despite the fact that we had a bad investment year, no banks are going bankrupt, the housing market is not on the verge of collapse and there is no threat of a layoff wave. Still, last year’s skyrocketing energy prices constituted a hefty economic blow, causing consumers to spend a larger portion of their income on energy. Something like that almost automatically causes a recession, because that money cannot be spent on anything else. And then there is the ECB’s policy on top of that.”


According to Knaap, the consensus is that it won’t be such a bad recession this time around, mainly because there are no mass layoffs and restructurings. “In that sense, falling energy prices are also good news, but not good enough. Incidentally, it could have been worse. Last year we consumed 25% less natural gas in the Netherlands, which is really a lot. Half of that can be attributed to the mild winter and the use of alternative energy sources, the other half is the price effect. Companies and consumers used less natural gas due to the high natural gas price. It is a positive discovery that we managed to consume substantially less natural gas without it really having much impact on our lives. For all we knew, despite our efforts to reduce our energy consumption, we could still have used the same amount of natural gas as before. Then we would be in a much worse situation now.”