Very balanced and informed summary of what we know and don’t know. An additional thought. If the relatively moderate inflation we have now, significantly affected by supply side disruptions that may be easing, legitimizes the retreat from extraordinary monetary ease, there may be a positive consequence. The massive accumulation of excess reserves and negative real risk-free rates has encouraged both leveraged recapitalizations of established businesses and the flood of “nontraditional” capital into illiquid ventures at unsustainable valuations, as well as the crypto bubble. This extreme, speculative financialization of enterprise both raises Minsky-type macro-financial risk and distorts the potential for productive speculation. Enough is enough, if not too much
Solid article on the theory and history of price controls, particularly in the context of inflation. I also think that we should keep in mind that a significant driver of inflation is the shift in consumption of services to goods. [1] It’s expected that the higher demand for goods will lead to a short term increase in prices and further we’d expect the goods/service balance to normalize as the pandemic hopefully wanes over the coming year. Price controls would largely only shift consumer preference from price controlled (i.e., rationed) goods to alternative goods that aren’t yet price controlled and simply change the specific goods experiencing inflation.
I’d also recommend Joseph Politano’s recent article, “Are Rising Corporate Profit Margins Causing Inflation?” [2] (It’s free). That article analyzes corporate profits to show that there isn’t any evidence that our current inflation corresponds to increasing corporate profit margins. E.g., despite higher car prices, car manufacturers have actually had a decrease in profits due to component shortages constraining volume and increased costs.
Politano also points out that the US’s WW2 Office of Price Administration had 160,000 employees at its peak. It would not be feasible for the US to legislate and build a comparably large government org in time to address our current inflation controls. Further, our modern economy is far larger and complicated, with substantial foreign firm integrations.
A shift in demand from services to goods should cause relative price changes, not absolute. If I spend more on goods, I have less to spend on services and prices fall accordingly. It’s only in a world where there is more money to spend on everything that you get jumps in the aggregate price level like we’ve seen.
Does anyone expect goods prices to fall back to prior levels upon normalization of supply & demand? Not that I can tell. Why not? Lots more money in the system is the answer.
If the supply of services falls at about the same level of demand is dropping there wouldn't be drop in prices for services even though there has been a shift of demand from services to goods.
Agree, if supply of everything drops you could still get an increase in the price level. But you would also expect prices to return to past levels once supply was restored - and no one expects that. Thus I conclude today's inflation is mostly a function of too much money in the system.
You nailed Venezuela and Argentina, but you missed the big country right between the two! Brazil has had a long and proud history of disastrous price controls, and the government (via Petrobras) set fuel prices until literally three months ago.
I was very interested in the escalation from benign price controls under war time over to the disastrous ones recently in Venezuela. This made me wonder what happened economically in the other big disaster of my life time, which is the post-Soviet liberalization programs where the situation had the same post apocalyptic tones as Venezuela for a few years.
Excellent article...We are (not only here, in Argentina) fed up with bullshit writers like that Isabella, those about the Modern Monetary Nonsense, and lots of local advocates of some other sorts of "voodoo economics"...
Thanks for this, while I broadly agree with you, what about rationing of certain items if you have actually set price controls. For example, 1 person can only buy 2 tubes of toothpaste if you have set price controls on toothpaste? This can atleast reduce the problem of hoarding?
The problem is we don’t like the idea of raising rates, raising taxes, nor cutting spending. We haven’t the faintest idea of how to become more productive in the areas where we need it most (I’ve been hearing about the need to relax zoning laws for 20 years). And we lack the will and sophistication to break up modern day oligopolies and other forms of rent-seeking (which are increasingly found in service businesses).
That leaves us clinging to the hope that tough talk from the Fed and modest balance sheet changes will bring inflation down (even with the tougher talk, real interest rates remain near record lows). If that gamble doesn’t pay off I expect we see price controls.
Perhaps, but my bet is that unless Trump is elected, we'll just see more rate hikes. The question is when rate hikes get big enough to start hurting employment.
Trump would order Powell to hold rates near zero? Well...MMT posits a zero interest rate world. Sovereign currency-issuing governments don't need to borrow from private financiers/bankers (and citizens only need to pay bankers fees, not interest). In that world, removing the supply bottlenecks is the correct solution to price rises. The government should never have thrown borrowed money at locked-down consumers, the government should merely have paid everyone's essentials bills, during lock-downs.
Anyway, let's see how your "bet" on rate hikes plays out. as well as Krugman's "hope" that inflation will fall, as supply chain blockages rectify themselves.
I keep failing to understand the basic model behind this second graph. If the government puts in a modest price ceiling above the point of intersection of the supply curve and the marginal revenue curve, why would the monopolist not just continue selling at the lower price? Why do we say that the price and quantity go up in this situation?
Could you draw a supply shock/bottleneck as a vertical line on those price/quantity plots? If so, rightwards of the supply/demand equilibrium has no visible effect on the market, but leftwards of the equilibrium opens a gap between consumer and producer expectations of prices. Wouldn’t that gap be filled by producer ambitions for profit, i.e. rising prices, which looks like inflation?
Remove the limit on supply and the original curves are reestablished? Prices will fall back or the supply curve will just extrapolate from the new price level?
The biggest problem is how prices are raised to keep the profit in the pocket of the share holder, however, wages never raise to match. In many cases the increase in prices is nothing more than price gouging. The corporations use trust practices and pricing agreements to keep their gouging 'acceptable' since because everyone is doing it, no one is.
Solid article, but I did not find the bit about cryptocurrency particularly convincing. Are the oil giants going to turn to the dark web and bitcoin to sell consumers petrol? Is Amazon going to get in on the act by using its fleet of drones to outsmart the government? At the end of the day, if smuggling were truly effective, then there really wouldn’t be much inflation in the first place.
I’d also be curious to know if hyperinflation is possible without a corresponding increase in the money supply.
I had only meant to show that crypto could only help to avoid price controls along the edges of an economy--when it comes to the main ways in which we spend our money, we must pass follow the rules. But perhaps I've misread what you were getting at with regards to crypto.
i mean, it's pretty simple. a price control is three separate policies, all of them bad:
1. a tax on the producer (as if production were a negative externality).
2. a subsidy to the consumer (but subsidies create deadweight loss relative to pure cash benefits).
3. a hypothecation linking the two. hypothecation is obviously a fallacy. you want to spend money on a given thing based on (a) how much total revenue you have to spend, and (b) the relative priority of that thing as compared to the priorities of all the other potential things you could be spending money on instead. hypothecation means the expenditure instead depends on an irrelevant specific revenue stream.
Hmmmm. This is very complicated. First off, I must salute Noah for taking a measured evaluation of the entire matter. Are price controls a good idea? Rarely. But Isabella Weber's op-ed did not deserve the amount of derision it attracted. I don't think it's a good idea in a crisis to mock someone else's suggestion. Besides, economists are hardly people to laugh.
Anyway, I think it all boils down to a rather tricky question: why is something selling at the price that it is.
And through that lens, it's helpful to think of opportunity costs. Suppliers will only produce a good if there's more value doing so. Price controls cut this out of the equation. Because they usually make goods cheaper, that's why they are created, they can create shortages. It's just not worth it to supply so much anymore.
On the consumer side, they can do a few very different things. The most straightforward consequence is that they benefit certain kinds of consumers since the good or service is now cheaper to obtain.
But that's linear thinking. If a good or service is cheaper to obtain at the same time that there's much less of it to obtain, then there will be even worse shortages.
There's another problem: people may buy the good not to use it but to resell it, especially when these are essential goods Therefore, vigorous black markets start springing up and the real price is nothing but a label. This is part of what destabilised the Soviet union
And the lesson is simple: if you alter one thing artificially (prices) but everything else stays the same( demand, the economy, the conditions of supply), you will create a distortion.
If the story is pretty negative, it invites the question as to when will price controls actually work.
Well:
a.) When they are not far away from the real price which kind of negates the point. This may be when the price controls do very little harm and benefits
b.) When possibility of resale is close to zero and demand is significantly low such as wartime
When inflation is driven by supply shocks and ours is, we can't fix it with price controls or with monetary policy either
If the economy is a television, these policies are like a remote, that is, a great indirect way of being in control. Sometimes, they work. Other times, the problems with the television are much more fundamental. All you will be doing is wasting your time. In this case, it could be much worse than just that
I think much too much dull plodding through unrealistic modeling to get to the real issues of reduced production and evasion. Effects depend on the scale of the difference between the price cap and the demand/supply equilibrium price, but generally price caps significantly below supply/demand equilibrium reduce production and encourage cap-evasion with consequent price increases to cover the costs and risks.
Very balanced and informed summary of what we know and don’t know. An additional thought. If the relatively moderate inflation we have now, significantly affected by supply side disruptions that may be easing, legitimizes the retreat from extraordinary monetary ease, there may be a positive consequence. The massive accumulation of excess reserves and negative real risk-free rates has encouraged both leveraged recapitalizations of established businesses and the flood of “nontraditional” capital into illiquid ventures at unsustainable valuations, as well as the crypto bubble. This extreme, speculative financialization of enterprise both raises Minsky-type macro-financial risk and distorts the potential for productive speculation. Enough is enough, if not too much
Solid article on the theory and history of price controls, particularly in the context of inflation. I also think that we should keep in mind that a significant driver of inflation is the shift in consumption of services to goods. [1] It’s expected that the higher demand for goods will lead to a short term increase in prices and further we’d expect the goods/service balance to normalize as the pandemic hopefully wanes over the coming year. Price controls would largely only shift consumer preference from price controlled (i.e., rationed) goods to alternative goods that aren’t yet price controlled and simply change the specific goods experiencing inflation.
I’d also recommend Joseph Politano’s recent article, “Are Rising Corporate Profit Margins Causing Inflation?” [2] (It’s free). That article analyzes corporate profits to show that there isn’t any evidence that our current inflation corresponds to increasing corporate profit margins. E.g., despite higher car prices, car manufacturers have actually had a decrease in profits due to component shortages constraining volume and increased costs.
Politano also points out that the US’s WW2 Office of Price Administration had 160,000 employees at its peak. It would not be feasible for the US to legislate and build a comparably large government org in time to address our current inflation controls. Further, our modern economy is far larger and complicated, with substantial foreign firm integrations.
[1] https://twitter.com/mattchagy/status/1466900351861211137
[2] https://apricitas.substack.com/p/are-rising-corporate-profit-margins
Ahh, missed the Joey post! Dang it. I'll add an update.
A shift in demand from services to goods should cause relative price changes, not absolute. If I spend more on goods, I have less to spend on services and prices fall accordingly. It’s only in a world where there is more money to spend on everything that you get jumps in the aggregate price level like we’ve seen.
Does anyone expect goods prices to fall back to prior levels upon normalization of supply & demand? Not that I can tell. Why not? Lots more money in the system is the answer.
If the supply of services falls at about the same level of demand is dropping there wouldn't be drop in prices for services even though there has been a shift of demand from services to goods.
Agree, if supply of everything drops you could still get an increase in the price level. But you would also expect prices to return to past levels once supply was restored - and no one expects that. Thus I conclude today's inflation is mostly a function of too much money in the system.
You nailed Venezuela and Argentina, but you missed the big country right between the two! Brazil has had a long and proud history of disastrous price controls, and the government (via Petrobras) set fuel prices until literally three months ago.
I like your line about Argentinian inflation-sensitive macroeconomists. It reminds me of the glut of Italian Thatcheroid microeconomists.
I was very interested in the escalation from benign price controls under war time over to the disastrous ones recently in Venezuela. This made me wonder what happened economically in the other big disaster of my life time, which is the post-Soviet liberalization programs where the situation had the same post apocalyptic tones as Venezuela for a few years.
Excellent article...We are (not only here, in Argentina) fed up with bullshit writers like that Isabella, those about the Modern Monetary Nonsense, and lots of local advocates of some other sorts of "voodoo economics"...
Hi Noah,
Thanks for this, while I broadly agree with you, what about rationing of certain items if you have actually set price controls. For example, 1 person can only buy 2 tubes of toothpaste if you have set price controls on toothpaste? This can atleast reduce the problem of hoarding?
It certainly does in wartime. But are people going to accept rationing of daily goods in peacetime? No, they'll just throw out whoever's in power.
The problem is we don’t like the idea of raising rates, raising taxes, nor cutting spending. We haven’t the faintest idea of how to become more productive in the areas where we need it most (I’ve been hearing about the need to relax zoning laws for 20 years). And we lack the will and sophistication to break up modern day oligopolies and other forms of rent-seeking (which are increasingly found in service businesses).
That leaves us clinging to the hope that tough talk from the Fed and modest balance sheet changes will bring inflation down (even with the tougher talk, real interest rates remain near record lows). If that gamble doesn’t pay off I expect we see price controls.
Perhaps, but my bet is that unless Trump is elected, we'll just see more rate hikes. The question is when rate hikes get big enough to start hurting employment.
Trump would order Powell to hold rates near zero? Well...MMT posits a zero interest rate world. Sovereign currency-issuing governments don't need to borrow from private financiers/bankers (and citizens only need to pay bankers fees, not interest). In that world, removing the supply bottlenecks is the correct solution to price rises. The government should never have thrown borrowed money at locked-down consumers, the government should merely have paid everyone's essentials bills, during lock-downs.
Anyway, let's see how your "bet" on rate hikes plays out. as well as Krugman's "hope" that inflation will fall, as supply chain blockages rectify themselves.
I keep failing to understand the basic model behind this second graph. If the government puts in a modest price ceiling above the point of intersection of the supply curve and the marginal revenue curve, why would the monopolist not just continue selling at the lower price? Why do we say that the price and quantity go up in this situation?
The basic idea is that the price ceiling prevents them from jacking up the price as much as they'd like, so they have to make it up on volume.
Where does effective demand (= purchasing power come from for expanded quantities?
The political narrative should be price controls are rations. Full stop.
I’m an interested layperson.
Could you draw a supply shock/bottleneck as a vertical line on those price/quantity plots? If so, rightwards of the supply/demand equilibrium has no visible effect on the market, but leftwards of the equilibrium opens a gap between consumer and producer expectations of prices. Wouldn’t that gap be filled by producer ambitions for profit, i.e. rising prices, which looks like inflation?
Remove the limit on supply and the original curves are reestablished? Prices will fall back or the supply curve will just extrapolate from the new price level?
I'm not sure I understand! I'll have another post about the economics of supply chain snarls soon!
The biggest problem is how prices are raised to keep the profit in the pocket of the share holder, however, wages never raise to match. In many cases the increase in prices is nothing more than price gouging. The corporations use trust practices and pricing agreements to keep their gouging 'acceptable' since because everyone is doing it, no one is.
Solid article, but I did not find the bit about cryptocurrency particularly convincing. Are the oil giants going to turn to the dark web and bitcoin to sell consumers petrol? Is Amazon going to get in on the act by using its fleet of drones to outsmart the government? At the end of the day, if smuggling were truly effective, then there really wouldn’t be much inflation in the first place.
I’d also be curious to know if hyperinflation is possible without a corresponding increase in the money supply.
I doubt oil giants will sell in crypto; they'll just sell overseas in overseas currencies, and cut back operations stateside.
I had only meant to show that crypto could only help to avoid price controls along the edges of an economy--when it comes to the main ways in which we spend our money, we must pass follow the rules. But perhaps I've misread what you were getting at with regards to crypto.
i mean, it's pretty simple. a price control is three separate policies, all of them bad:
1. a tax on the producer (as if production were a negative externality).
2. a subsidy to the consumer (but subsidies create deadweight loss relative to pure cash benefits).
3. a hypothecation linking the two. hypothecation is obviously a fallacy. you want to spend money on a given thing based on (a) how much total revenue you have to spend, and (b) the relative priority of that thing as compared to the priorities of all the other potential things you could be spending money on instead. hypothecation means the expenditure instead depends on an irrelevant specific revenue stream.
https://medium.com/effective-economics/the-problem-with-price-controls-14b4ee116bf7
Hmmmm. This is very complicated. First off, I must salute Noah for taking a measured evaluation of the entire matter. Are price controls a good idea? Rarely. But Isabella Weber's op-ed did not deserve the amount of derision it attracted. I don't think it's a good idea in a crisis to mock someone else's suggestion. Besides, economists are hardly people to laugh.
Anyway, I think it all boils down to a rather tricky question: why is something selling at the price that it is.
And through that lens, it's helpful to think of opportunity costs. Suppliers will only produce a good if there's more value doing so. Price controls cut this out of the equation. Because they usually make goods cheaper, that's why they are created, they can create shortages. It's just not worth it to supply so much anymore.
On the consumer side, they can do a few very different things. The most straightforward consequence is that they benefit certain kinds of consumers since the good or service is now cheaper to obtain.
But that's linear thinking. If a good or service is cheaper to obtain at the same time that there's much less of it to obtain, then there will be even worse shortages.
There's another problem: people may buy the good not to use it but to resell it, especially when these are essential goods Therefore, vigorous black markets start springing up and the real price is nothing but a label. This is part of what destabilised the Soviet union
And the lesson is simple: if you alter one thing artificially (prices) but everything else stays the same( demand, the economy, the conditions of supply), you will create a distortion.
If the story is pretty negative, it invites the question as to when will price controls actually work.
Well:
a.) When they are not far away from the real price which kind of negates the point. This may be when the price controls do very little harm and benefits
b.) When possibility of resale is close to zero and demand is significantly low such as wartime
When inflation is driven by supply shocks and ours is, we can't fix it with price controls or with monetary policy either
If the economy is a television, these policies are like a remote, that is, a great indirect way of being in control. Sometimes, they work. Other times, the problems with the television are much more fundamental. All you will be doing is wasting your time. In this case, it could be much worse than just that
I think much too much dull plodding through unrealistic modeling to get to the real issues of reduced production and evasion. Effects depend on the scale of the difference between the price cap and the demand/supply equilibrium price, but generally price caps significantly below supply/demand equilibrium reduce production and encourage cap-evasion with consequent price increases to cover the costs and risks.