Why Government Fixes for Inflation Usually Fail

Editor’s Note: The following is adapted from Chapter Four of Inflation: What It Is, Why It’s Bad, and How to Fix It by Steve Forbes, Nathan Lewis, and Elizabeth Ames, with permission from Encounter Books.

H ow do countries control inflation? The answer is: very badly. The misunderstanding of money that leads governments and central banks to devalue currency too often means they’re ill-equipped to put the Inflation Genie back in the bottle. History is littered with attempts to end monetary disasters that have failed and frequently made things worse.

This is because policymakers are usually unable, or unwilling, to acknowledge the real reasons why their currency has lost value. Instead, they blame markets: People are spending too much money! Businesses are gouging! The economy is overheating! Do something!

Often, that something is pressuring businesses to lower prices, or getting people to spend less money. These strategies never work.

Many countries attempt to shore up their plunging currency by artificially increasing demand for it through so-called “capital controls.” Argentina has periodically restricted companies from doing business in dollars in an attempt to shore up its beleaguered peso. The use of credit cards has been limited, too. In 2021, after a brief dip, Argentina’s inflation (which had reached rates of 50 percent) was once again soaring. The value of the Argentine peso had fallen from 15 to the dollar in 2017 to 107 to the dollar.

Price controls are another favorite method, often accompanied by threats and shaming from authoritarian regimes. Turkey’s strongman President Recep Tayyip Erdoğan responded to rising food prices resulting from a sliding Turkish lira by blaming foreign “food terrorists” he claimed were working with international speculators. He called on citizens to report food sellers who were “bullying” consumers, and ordered price inspections of food shops and warehouses. The efforts have had virtually no effect on Turkey’s skyrocketing inflation.

With an inflation rate that’s the highest in the world, Venezuela at one point imposed tight price controls on everything from corn flour and car parts, to children’s toys. The government sent a small army of price inspectors armed with central bank data in pursuit of supposed price gougers. After further devastating the nation’s economy, the controls were eventually relaxed. Meanwhile, the government keeps printing money to help fund its soaring salaries, which went up at least 60-fold in one year alone.

Price controls were also a favorite method of the 37th president of the United States. Facing a mild inflation in 1971, Richard Nixon responded with a 90-day freeze on wages and prices — the only peacetime wage and price controls in U.S. history. Nixon was convinced that the controls, combined with the Fed’s monetary expansion, would boost employment with minimal inflation. The president did win reelection, but his initiatives did anything but tame price increases.

Another inflation-fighting strategy is “austerity,” a combination of harsh tax increases, super-high interest rates, government spending cuts and, yes, more currency devaluation. These so-called remedies are based on a flawed critique of the Great Depression. Back then (and, too often, today) Keynesians saw inflation as primarily a non-monetary phenomenon. The objective of austerity measures is to tamp down inflationary price increases by creating a “recession to break the back of inflation.”

Austerity is a favorite inflation-fighting “remedy” of the International Monetary Fund (IMF), the global organization of 190 countries whose mission, in part, is to foster global financial stability. Nations plagued by severe inflation often turn to IMF experts. They shouldn’t. States around the world have seen their crises worsened and their economies devastated after taking the agency’s advice.

The classic example of IMF malpractice was its intervention in the Asian currency crisis in the late 1990s. As the dollar rose during that time, it put pressure on the values of dollar-linked currencies in Asia. Traders dropped the Thai baht and other currencies in the region, and instead bought dollars.

The IMF, however, insisted the problem lay with the Thai government’s deficit. The agency recommended an austerity program of tax hikes and spending restrictions to turn the government’s tiny deficit into a surplus. The strategy, however, was a disaster. The value of the baht fell further.

In the late 1980s and early 1990s, Russia made a similar mistake of consulting the IMF when facing a spiraling inflation caused by the collapse of the ruble. Demand for the ruble plummeted as Russia began to conduct more international trade in U.S. dollars as part of President Mikhail Gorbachev’s “Perestroika” policy of warmer relations with the West. At the same time, Russia’s bureaucratic Communist government began to finance its enormous deficits by printing new banknotes. The combined result was a roaring hyperinflation.

Russia’s IMF advisers recommended slowing the hyperinflation by reducing the supply of rubles. The problem, however, was not supply per se, but that no one trusted the ruble. By declaring a huge swath of its currency worthless, Russia made this problem exponentially worse.

To stem the devastation, the IMF then recommended — and Russia imposed — a round of austerity that included a raft of new taxes in addition to spending reductions, with the goal of creating a fiscal surplus. The tax hikes simply accelerated the downward pressure on the ruble. The IMF-created disaster led to the election of strongman Vladimir Putin.

Inflation-fighting regulations and taxes fail because they don’t properly address the cause of a crisis — a decline in the value of money. The failure to address this central problem produces “solutions” that, in one way or another, further undermine confidence in a government and its currency, making matters worse.