With more discouraging inflation news and cost increases stretching household budgets, the growing chorus chanting “do something” will no doubt increase in volume. Still, doing something about rising inflation rests with the Federal Reserve and involves pain. How long the pain lasts — high unemployment, slow economic growth and falling disposable income — depends on the Fed’s effectiveness in convincing the public that lower inflation is coming. The public’s inflation expectations are key to the Fed meeting its 2% inflation target, and there’s no way around that fact.
With that harsh truth in mind, certain “do something” policies could make things worse if implemented. People who study policy contribute to society by suggesting solutions and their trade-offs or, just as importantly, advising what not to do.
Enforcing wage and price controls tops the list of what not to do about inflation. More specifically, what we mean by wage and price controls is price ceiling. As the term suggests, these are legal barriers to raising prices above a certain point.
Governments and administrations worldwide have enforced price ceilings for thousands of years. The federal government is no exception. Currently, members of Congress have proposed legislation to prevent price gouging and charging high prices. Make no mistake. These proposals are price ceilings.
Political incentives to enforce price caps are tempting. Firstly, the government is doing something and secondly, the aim of keeping prices from rising will be successful for some time.
But then what? Will we end price ceilings at some point? When will we end them? In addition to those questions, there are continuing implications because this type of policy does not exist in a vacuum. Price ceilings send the necessary signals prices send to buyers and sellers. Price flexibility adjusts to public tastes, demands, and other economic dynamics, all of which do not stand still.
Since price ceilings eliminate sellers’ ability to raise their prices, fewer products are produced. Scarcity is the result. If you believe the deficit situation we’re experiencing now is bad, price ceilings make them a good deal worse.
Price ceilings also invite other consequences such as the rise of black markets and deterioration of product quality.
Over time, and in the face of increasing scarcity, governments may resort to rationing high-demand resources and consumer goods. In the 1970s, due to price ceilings on some domestically produced oil, gas lines were formed where states established odd-even rationing based on the car owner’s license plate number. Going back in time, anyone who lived during World War II will tell you about ration coupons on all kinds of goods.
Still, the price ceiling is likely to be lifted at some point. The result is inevitably a spike in inflation as price flexibility returns and prices again adjust to accurately reflect supply and demand conditions.
Taken as a whole then – the initial price freeze, the surge in deficits and the eventual spike in inflation – there is only one conclusion: price ceilings are self-defeating. Accordingly, we assume that corrective policy rests with the Fed and that it has the means and the will to pursue its efforts to achieve price stability.
Data, theory and history are not on the side of price ceiling advocates. Indeed, after the last American episode when national price ceilings were established in the early 1970s, economist Milton Friedman best summarized the social and economic consequences:
“There is hardly a person today who does not recognize that price and wage controls mean more inflation – not less – and that they are disruptions, distortions, reductions in production, and increases in government power over the individual.”
In the end, if a price ceiling is established, it will be a victory of hope over experience.
Jim Granato is dean of the Houston Hobby School of Public Affairs, where MC Sunny Wang is professor and associate dean for graduate studies. He co-authored The Role of Policymakers in Business Cycle Fluctuations. He wrote this for the Dallas Morning News.
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