Would government price controls help solve our inflation problem?

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Listener Rebecca Kleister asks:

Could a temporary wage and price freeze curb inflation and lessen the possibility of a recession?

Inflation continues to set multi-decade records, with consumer prices rising at an annual rate of 9.1% in June, according to the Labor Department.

In response to rising prices, the Federal Reserve has raised interest rates this year, including a second consecutive hike of 0.75% on Wednesday. Some experts fear a recession could result from the Fed’s attempts to slow the economy.

A recent survey by the McCourtney Institute for Democracy, in conjunction with APM Research Lab, asked Americans how the country should fight inflation. There was not much consensus, but the main responses were to cut public spending and impose temporary price freezes.

The United States has actually used wage and price freezes as a tactic to curb inflation at various times in its history, including World War II and during Richard Nixon’s administration in the early 1970s. This was the last time the country applied blanket price controls.

But a majority of economists disagree that 1970s-style price controls could reduce inflation over the next year, according to a survey by the University’s Booth School of Business. of Chicago published in January.

While a wage and price freeze could temporarily stifle inflation, it will only exacerbate the problem once we lift those controls, according to Hernan Moscoso Boedo, associate professor of economics at the University of Cincinnati. .

You can think of it as a pressure cooker. “If you try to control the pressure by holding the lid, well, eventually it will explode if you don’t have the valve that releases the pressure,” Moscoso Boedo said.

Let’s say the government controls prices and the Fed decides to keep interest rates low. That basically means the Fed is printing money, Moscoso Boedo said. (Conversely, when it raises interest rates, it is essentially trying to reduce the money supply in the economy.)

The money has to go somewhere and the pressure will mount, said Moscoso Boedo. This pent-up demand will influence prices, causing them to skyrocket once controls are removed.

At the start of the COVID-19 pandemic, when millions of Americans lost their jobs, the government sent billions of dollars in relief checks. Moscoso Boedo pointed out that much of that money has gone unspent due to business closures, creating pent-up demand – fueling inflation.

Moscoso Boedo added that price controls were producing shortages. For example, if a vendor thinks their product is worth $10 and you force the price to stay at $9, that vendor can hold inventory for that product until the price check is complete.

In addition, controls can lead to illegal markets. He argued that if the price of a gallon of milk is supposed to stay at $2 even though consumers would pay $3, you’ll see less milk supplied to the store. Some people would take this opportunity to sell a gallon of milk under the table for $3.

According to the Heinz History Center, this happened during World War II. The prevailing price controls then pushed independent sellers to secretly buy and slaughter animals, then resell the meat at higher prices.

It would also be difficult to figure out how to price millions of products in the vast and complex US economy, said Peter Orazem, an economics professor at Iowa State University.

“Prices may not be the same everywhere. Some places may have too much of a product, and other places have too little. You want product to move from places where you have a surplus to places that have shortages, and price signals create that incentive,” Orazem said.

“If you don’t have a pricing system that responds to these relative supply and demand shocks, you’re going to end up with an inefficient allocation of resources across the economy.”

Orazem said that if certain products are in short supply, ideally you would want prices to increase to incentivize companies to supply more of those products.

“The general consensus is that the damage caused by wage and price controls far outweighs any benefits,” he said.

And if there was a wage freeze, it could discourage people from accepting work because they are being offered less than they would otherwise be paid, Moscoso Boedo said.

While many economists are critical of the idea of ​​a national price and wage freeze, some — like Isabella Weber of the University of Massachusetts, Amherst — favor strategic price controls on certain products.

Weber, arguing for this approach in an opinion piece for The Guardian, wrote that after World War II price controls could have remained in place while the United States transitioned to an “economy of after the war” instead of raising them in “a single big bang”. .” Some economists advocated this at the time, Weber pointed out. They argued that price controls should be lifted once “supply and demand for any major commodity” is in balance.

And price controls can be beneficial if applied selectively to, say, a monopoly, wrote Christopher Neely, vice president of the Federal Reserve Bank of St. Louis. Neely said that because monopolies typically sell less of a good and at a higher price than competing firms, price controls could force them to sell more of that good at a lower price.

The minimum wage is also considered a form of price control, with wages being the price of labor, and it is in effect across the country. But in this case, the government is setting a floor for what people should be paid, instead of a cap — or cap — on their earnings.

Those advocating for a higher minimum wage, or price floor, say raising it could lift millions out of poverty.

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James V. Hayes