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December 4, 2000

NOTE TO EDITORS

Lowering Electricity Prices through Deregulation, the latest edition of the New York Fed’s Current Issues in Economics and Finance is available.

Thomas Klitgaard and Rekha Reddy find that the ongoing deregulation of the nation’s electricity industry should ultimately lead to efficiency gains for the industry and cost savings for households and businesses, even though reforms so far have been accompanied by certain problems.

According to Klitgaard and Reddy, structural reforms at the federal level have resulted in the creation of a wholesale electricity market in which independent power producers compete for profits with the utilities. The most efficient firms prosper at the expense of their rivals—an outcome that motivates providers to reduce production costs by developing new technologies and streamlining operating procedures. A drop in production costs should, in turn, translate into lower rates for consumers—lower, that is, than the rates that would have prevailed under a regulated system.

Adding to competitive pressures on the industry, according to Klitgaard and Reddy, are state initiatives to create a competitive retail market for electricity. If households and businesses have the option to buy electricity from suppliers other than the local utility it will help ensure that the cost savings realized at the wholesale level are passed on to consumers, the authors say.

Although Klitgaard and Reddy stress the benefits of deregulation, they acknowledge that complex issues and significant operational challenges still have to be resolved. Among the difficult choices for the authorities are:

how to coordinate the output of multiple providers so that the supply of electricity continually adjusts to changes in demand,
how to ensure that a deregulated system possesses sufficient capacity to meet needs during peak-load periods, and
how to establish an ongoing role for government to guarantee that participants in the electricity market will comply with fair business practices.

Thomas Klitgaard is a research officer at the New York Fed; Rekha Reddy, formerly an assistant economist at the Bank, is now a senior project manager for the New York City Economic Development Corporation.

Contact: Douglas Tillett or Steven Malin

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