The Corner

Monetary Policy

No, We Shouldn’t Use Price Controls to Fight Inflation

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UMass economics professor Isabella Weber has taken to the pages of The Guardian to argue for price controls to fight inflation.

Weber writes:

Today economists are divided into two camps on the inflation question: team Transitory argues we ought not to worry about inflation since it will soon go away. Team Stagflation urges for fiscal restraint and a raise in interest rates. But there is a third option: the government could target the specific prices that drive inflation instead of moving to austerity which risks a recession.

Making price controls seem like the reasonable, above-the-fray option is quite the rhetorical move. First of all, there aren’t really two camps on this issue among economists; there are too many to count. But let’s grant that there are only two, Team Transitory and Team Stagflation. Both of those positions are based on economic reasoning and have a chance of being right. Price controls are set apart as the third way by virtue of being certainly wrong.

Weber gets the causation backward right from the start. She writes that “a critical factor that is driving up prices remains largely overlooked: an explosion in profits.” It makes no sense to say that profits drive up prices in competitive markets. Profit is defined as revenue minus costs. For profits to go up, something has to change about revenue and costs. The equilibrium price of a good is not in any way dependent on profit.

What has happened is the exact opposite of what Weber contends. The general increase in prices has caused an increase in profits since higher prices mean more revenue for firms. (Producers are facing higher costs, too, as the producer price index has also increased significantly, but at least for now, the increase in revenue has balanced that out on an economy-wide level.)

The only way for firms to drive up prices by increasing their profits would be if they had pricemaking power — i.e., if they were monopolistic. Weber never provides any evidence that firms suddenly became monopolistic in the past few months and raised their prices enough to cause a significant increase in the price level. It would be quite odd if they had this power all along and only chose to use it now, all at the same time.

Weber uses the following metaphor:

If your house is on fire, you would not want to wait until the fire eventually dies out. Neither do you wish to destroy the house by flooding it. A skillful firefighter extinguishes the fire where it is burning to prevent contagion and save the house.

This doesn’t work in a few respects. First, the increase in prices is not the fire. The fire is that there’s an imbalance between supply and demand. An increase in prices is the fire alarm, so to speak, alerting everyone to this reality. You don’t put out a fire by turning off the fire alarm, and you don’t solve inflation with price controls.

Second, who is the “skillful firefighter” in real life? Who is the person or group of people with sufficient knowledge of the economy to know which prices need to be controlled and what they need to be set at? The president? The Department of Commerce? Congress? The UMass economics faculty?

In essence, Weber is upset at an indicator of the problem, not the problem itself. Higher prices are an indicator that there’s an imbalance between supply and demand, and they’re used to coordinate behavior. They communicate, “Hey, there’s a need over here!” to people who could help fix the problem.

We’ve seen this happen in the supply-chain industry, where record levels of private investment are flowing in. People are very upset by high shipping costs, so there’s a lot of money to be made in solving the problems that are making them upset. Companies see the high profits in the supply-chain sector and want in on the action, increasing competition and spurring innovation. Competition and innovation mean undercutting, which will lead to a decline in prices that erodes the current outsize profits.

Weber says multiple times that she is advocating “strategic” price controls. What exactly Weber’s strategy is, she doesn’t say. Which prices should be controlled, and what should they be set at? It’s unfair to expect her to lay out her whole plan in an op-ed, but she provides no examples of what her strategic price controls would be.

She does make a big to-do out of the price controls imposed by the Roosevelt administration during World War II. She writes that during the war, “price rises were low, while the increase in output was almost beyond imagination.” She doesn’t mention that there were ration books or that the increase in output was in the production of airplanes, tanks, and bombs to fight the largest and most destructive war in human history.

Weber points out that “some of the most distinguished American economists of the 20th century called for a continuation of price controls” after the war. What Weber misses is that they were wrong. Paul Samuelson, for example, wrote that the end of the war and the control economy would lead to “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” Harry Truman ignored the doomsayers, got rid of price controls, slashed government spending, and the post-war economic boom happened instead.

“Strategic price controls” (strategy TBD) are not a tool to fight inflation. They are a retread of past ideas that didn’t work before and won’t work now because they are based on fundamentally unsound economics. Isabella Weber doesn’t know what prices should be set at, and neither does anyone else.


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