Tuesday, February 5, 2013

Price controls and horseshit

Argentina has announced that informal price controls will be in place for the next few months. A good thing if you ask me. Yet, you can expect a barrage of criticism about the inefficiency of price controls in the media, and by 'expert' economists to follow. Note, however, that from 1941 to 1946, during World War II, the United States applied a very successful program of price controls. A good description can be found in John Kenneth Galbraith's A Theory of Price Control, in which he describes his experience as Commissioner of Prices.

An interesting story Galbraith used to tell (see here) is that they would have a sign to tell when some industrialist that wanted to hike prices tried to suggest that he would go broke if that didn't happen. They would move their index and middle fingers like the antennas of ants. The story went that this little ant rolled a dung of horseshit up a mound, and when it lost control of it, and the dung rolled down in the direction of the anthill, all the ants nervously signaled each other (moving their antennas) to "stop that horseshit."

Prices increased on average 5.8% annually between 1941 and 1946 (they accelerated a bit in 1947, after price controls were lifted, but didn't get out of control). Note that the rate of unemployment was at very low levels reaching 1.2% in 1944. This is not to say that all price control systems work perfectly, but that under certain circumstances they might be a useful way of controlling inflation.

PS: By the way, the US had an extensive bureaucratic machine to enforce the application of price controls. Also, certain shortages were considered acceptable during a war period. But note that similarly certain shortages should be normal in a developing country with a balance of payments constraint.

7 comments:

  1. It seems to be that the Nixon wage-price controls in the early 1970s were quite effective. They began in the summer of 1971 and began phasing out in late 1973. During this period we see a substantial drop in the inflation rate:

    http://www.tradingeconomics.com/charts/united-states-inflation-cpi.png?s=cpi+yoy&d1=19700101&d2=19730228

    This is despite the fact that, according to Wikipedia:

    "93% of requested price increases were granted and seen as necessary to meet costs."

    http://en.wikipedia.org/wiki/Incomes_policy#United_States

    The whole experiment was killed by the first OPEC oil shock in October. The Nixon administration did not have a steady enough hand to impose the sort of controls that would be necessary for a shock of this magnitude. Nevertheless, I would say that the 1971-1973 controls were a success. Especially considering the fact that they were using expansionary fiscal policy at the time:

    http://www.tradingeconomics.com/charts/united-states-government-budget.png?s=fddsgdp&d1=19700101&d2=19740228

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    1. Thanks for the links. Yes price controls and income policies in general have been one of the most unjustly attacked policy tools by Monetarists, Austrians and right-wingers in general.

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  2. I agree that tackling expectations is key in reducing inflation, especially when we're talking about higher inflation rates (ie above 10%) . But to think that price controls only, without the appropriate monetary and fiscal contractions are the solution is ludicrous. They're a tool governments generally use when they cannot afford politically to take the necessary painful measures to end inflation. That is why they are considered to be a joke by most economists.
    The current measure by the Argentine government is even more likely to fail because the government proposes to curb inflation only by fixing only some prices, namely, prices of goods. Does anyone really think that businesses will keep prices fixed when their labor costs increase 20% a year? You could think that fixed prices will lead to slower nominal wage increases, but there is a mismatch between the periods in which the wage agreements through collective bargaining take place and this new price agreement scheme takes place. Businesses will increase prices on the 1st day of the end of price control (after 60 days) however, wages are set once a year, so the price control scheme will not be taken into account when setting wages.
    So the proposed plan is a big joke, which in the best case will slow inflation down temporarily, because the current administration is unable or unwilling to take the necessary measures to actually solve the inflation issue, namely, tackle expectations, and fiscal and monetary expansions.

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    1. Hi Juan Sebastián. Nope we don't agree on expectations at all. For my part I think that agents react to actual not imagined things. And if inflation results from cost push, not demand pull, it is far from ludicrous to suggest that price controls are necessary, and contractionary demand policies utterly irrelevant. Do you suggest that inflation is always demand driven? By the way, in the US only in four short periods (mid-1940, early 1950s, late 1960s and late 1990s) did unemployment fell below 4%, meaning something close to full employment. In other cases, it would seem (including the 1970s) that inflation was NOT caused by demand.

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    2. On the other point, the more practical case of whether it will succeed or not, what I suggested in the post script is that you need a bureaucracy to make it work. And note that even in cases where demand was a crucial component of inflationary pressures, like the US during WW-II, it did work. So with a bureaucracy in place it could certainly work in Argentina, where inflation results from cost pressures (nominal exchange rate devaluation and wage increases).

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  3. By the way, if slowing down the economy had an effect on inflation, last year you should have seen a significant reduction of inflation in Argentina (just to confirm that demand is NOT the problem).

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  4. From Hugh Rockoff's "Drastic measures A history of wage and price
    controls in the United States" (1984, p. 108):

    "In a sense the democratic process wrote its own evaluation of controls: Selective controls were a failure; the hold-the-line policy was initially a success; but failed when, at the end of the war, the constraints on collective bargaining and rationing became too confining. The statistical record, on the whole, tends to confirm this judgment. Perhaps the simplest question is, Did controls "work" in the elementary sense that the rate of inflation was kept below some arbitrarily small figure, say 5 percent per year? The answer that emerges (Table 4.3) depends on the particular subperiod one examines. From April 1943, when President Roosevelt issued the Hold-the-Line Order, until June 1946, when ontrols temporarily expired, inflation was held to a measured rate of only 2.3 percent per year. The true rate was probably somewhat higher, but even with an allowance for errors in the published index - an estimate of inflation partially corrected for these errors is in parentheses - controls were a success in this elementary sense. On the other hand, under less than total control the rate of inflation was not effectively restrained. Of particular interest are the periods April 1942 to April 1943 and February 1946 to June 1946 which give the rate of inflation under the General Maximum Price Regulation and under President Truman's
    reconversion policy, respectively. In both cases the economy was under extensive price controls, but in neither case was the rate of inflation held down. The difference seems to be that during the high tide of price controls, they were backed up by a vigorous enforcement effort and three important supplementary measures - wage controls, the seizure of noncomplying industries, and rationing both of resources and of final products."

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