Targeted support, not subsidies, can best protect people when inflation surges – IMF

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The International Monetary Fund (IMF) said targeted, temporary income support is the most effective and cost-efficient way for governments to protect vulnerable households during cost-of-living crises.

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IMF disclosed this in its latest World Economic Outlook, noting that broad-based subsidies can impose higher costs on public finances.

The IMF report examined the economic consequences of cost-of-living crises and the effectiveness of government interventions across 76 countries over three decades.

The financial institution said consumer subsidies could require three to six times more fiscal resources than targeted cash transfers to provide the same level of protection to lower-income households. In contrast, producer subsidies could cost 14 to 22 times more.

According to the lender’s report, disruptions to global commodity markets, including those following Russia’s invasion of Ukraine in 2022 and conflicts in the Middle East, have driven up prices for essential goods and services such as food and energy.

The IMF said these episodes often have lasting consequences beyond the initial price surge. It said this makes essentials more expensive relative to other goods, weakens household purchasing power, and complicates central banks’ efforts to control inflation.

“Inflation expectations also rise and stay above pre-crisis levels for years, suggesting that these episodes may complicate efforts by central banks to control inflation,” the report said.

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It added that real wages could fall and remain below their previous levels for an extended period.

The Fund explained that poorer households bear a disproportionate share of the burden because food and energy make up a larger share of their spending than they do for wealthier families.

It noted that the effects on poverty and inequality were severe in lower-income countries, where necessities account for an even larger share of poor households’ expenditure.

Subsidies carry higher fiscal costs

The IMF said governments often responded to cost-of-living pressures with broad-based measures to suppress price increases, including tax reductions, producer subsidies, lower customs duties, and price controls.

According to the report, advanced economies had relied more heavily on reductions in value-added and excise taxes on food and energy.

Emerging markets and low-income countries also more often used measures targeting production costs and supply chains.

Governments also provided income support, with advanced economies using more targeted transfers and poorer countries more often introducing broad-based wage and pension increases.

However, the IMF said these interventions differed in their effectiveness and the financial burden they placed on governments.

It identified targeted, temporary transfers as the preferred approach because they direct assistance to households most in need, preserve limited government resources, and allow market prices to reflect scarcity.

On the other hand, the financial institution said price-suppressing measures can be expensive because much of the support may benefit households that do not need it.

The report cited Europe’s 2022–2023 energy crisis, during which less than 20 cents of every euro spent suppressing electricity, natural gas and gasoline prices reached the poorest fifth of households.

“Subsidising producers can cost 14 to 22 times more than targeted income support,” the IMF said.

It also warned that keeping prices artificially low could weaken incentives to conserve scarce resources.

When several countries adopt such measures at the same time, they can drive up global prices and worsen economic pressures on lower-income countries, the Fund said.

“Producer subsidies are even less efficient. Because they lower production costs rather than directly supporting households, foreign consumers benefit through lower export prices of downstream products.

“As a result, taxpayers pay more to benefit people and businesses in other countries rather than vulnerable families at home,” the lender stated.

Temporary, targeted interventions

The Fund recommended that governments make assistance temporary and deliver it through targeted income-support programmes.

It said the measure could be implemented by expanding existing social protection systems that can be scaled up quickly during crises.

“Assistance, when warranted, should be temporary and delivered through targeted income-support measures, ideally using existing social protection systems that can be scaled up quickly,” it said.

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It said broader interventions might be necessary in exceptional circumstances, including acute food insecurity, heightened risks of social unrest or serious difficulties in identifying and reaching eligible beneficiaries.

However, such support should be designed around the temporary component of a price shock rather than permanently higher prices, with clear deadlines for ending the measures.

Where price controls or subsidies are unavoidable, the IMF advised governments to focus narrowly on goods and services consumed disproportionately by vulnerable households while preserving market signals as much as possible.