Event Debrief: Feeling the Heat - How Households Manage High Electricity Bills

Key Takeaways 

• As global average temperatures increase, the need for air conditioning will mount, driving higher energy prices.
• Higher energy prices act as financial stressors, particularly for low-income households, resulting in consumers both reducing the amount of cooling they use and reducing spending in other categories to compensate for higher bills.
• Effective policy solutions are needed to help households manage higher energy costs and benefit from the potentially life-saving effects of cooling.

As many readers can attest, energy bills are on the rise. Nominal average monthly electricity bills in the United States increased 13% from 2021 to 2022, largely as a result of Russia’s invasion of Ukraine, which sent shockwaves through global energy markets. Even after accounting for inflation—which was 8% in 2022—electricity bills increased by 5%. 

According to Abigail Ostriker, Postdoctoral Fellow at the Harvard University Center for the Environment, many consumers are “feeling the heat” of these higher prices. At a February 12 Energy Policy Seminar, Ostriker explained how understanding how consumers change their behavior to deal with rising prices is an important aspect of studying climate adaptation, as higher average global temperatures are expected to drive increased demand for electricity.

Using anonymized bank transaction data for customers of a major U.S. bank from 2018-2019, Ostriker and colleagues set out to measure the two primary techniques that consumers might use to manage high energy bills induced by extreme heat: through own-good substitution (respond to the higher prices by cooling less) or through an income effect (reduced consumption of other goods as a result of higher energy bills). Pairing bank transaction data with daily temperatures allowed the researchers to investigate how the relationship between heat and electricity payments varies by income and how higher electricity payments may affect or crowd out discretionary spending.

The latter effect—which is known in the literature as “heat or eat?”—is a real dilemma facing an increasing number of people, especially those in lower income brackets. Energy bills already create financial stress for many Americans: late payments or nonpayment can result in shutoffs, and recent data show that more than 20 million households are behind on their utility bills. As average temperatures increase, and cooling becomes more of a necessity than a luxury, costs are likely to increase and exacerbate this issue.  

Looking only at customers above a certain income threshold and with a minimum number of monthly transactions (including regular utility payments), the authors were able to match bill payments to temperature in a 30-day window (aggregated daily minimum and maximum temperatures or “cooling degree days”) within a given census block—thereby achieving a relatively granular measure of the individual correlation between payments and cooling degree days (CDDs). By using individual-level transactions rather than thermostat data, the authors were able to reduce measurement error and also include lower-income households that probably don't have smart thermostats. As a result, the study contributes new insights to the literature on the income substitution and consumption smoothing effects of energy bills and other impacts of extreme temperatures.

Using this approach, the authors concluded that, compared to benchmarks, lower income households spent more on cooling per degree of higher temperature (Celsius). They observed a significant income effect of higher energy bills—each dollar of additional spending on energy displaced a significant amount of other spending for low-income households. Spending was also suppressed in the weeks immediately leading up to the date that utility bills were due. They also found that low-income households cool much less intensively than high-income households when faced with higher average temperatures (own-good substitution / consumption smoothing).  

The authors also looked at the relative cost and benefits of increased cooling, which could help save lives but increases electricity bills. They found that, while reducing cooling results in electricity savings on hot days, the cost of less air conditioning use (measured by the increase in heat-related deaths and value of a statistical life) is much higher. There is therefore a significant policy incentive to help reduce the burden of higher electricity costs resulting from climate change-induced extreme heat, particularly for lower-income households.

As a result, even with strong private incentives to adapt to climate change, low-income households may not have the resources to do so. Higher temperatures result in lower-income households cutting back on both energy and other consumption—causing both an own-good substitution and income effect. Though this is clearly a problem, more work is needed to pin down effective policy responses—a challenge that Kennedy School graduates should take on.