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Inflation: No time for price controls

Calls for governments to control prices directly instead of relying on monetary policy should be rejected.

Last year central banks argued that the increase in inflation was mostly transitory. However, it is now spreading globally, with wages also rising in some countries. Is it time for price controls?

Using macroeconomic policy to conquer inflation rather than pursuing growth and employment was espoused by the UK in 1984 and gradually became the conventional wisdom globally. Central banks were tasked primarily with achieving price stability.

The aftermath of the Global Financial Crisis triggered the first serious doubts about that mantra. Why still focus on price stability – which had been broadly achieved – when there were more pressing concerns?

So central bankers widened their ambitions to include growth, jobs, financial stability, fiscal sustainability and green policies.

But inflation ended 2021 at 7% in the US and has reached 5% or more in the UK and eurozone. It exceeds 36% in Türkiye and 50% in Argentina.

Initially the pandemic was blamed for shortages of goods and workers, with temporary lockdowns causing a transitory inflation rise.

But with the benefit of hindsight, and from a demand perspective, interest rates were slashed, quantitative-easing expanded and budget deficits widened in response to the pandemic, triggering in the US an extraordinary acceleration in money-supply growth. And from a supply perspective, suspending markets during lockdowns made pre-pandemic prices an increasingly irrelevant guide to the future. When markets re-opened, supply shortages were revealed.

Yes, the inflationary trends could rapidly unwind if the huge US fiscal stimulus is about to reverse, but monetary stimulus has lifted the value of American household financial assets well above pre-pandemic levels. So whatever the public sector takes away from demand, the household sector could more than add back, we believe.

Some have claimed that greedy corporations have created inflation by raising prices during the pandemic to boost their profits. US profits have grown enormously over the past two years. But many of the sectors with the strongest profits growth have seen the smallest price increases. And, anyway, the profit share in GDP had been rising for around two decades when inflation was low or even falling.

Yet fears that severe monetary tightening could cause another recession, mean some are arguing for the imposition of price controls. And if there is a case for ‘tailored controls’ on prices, there might also, in time, be a case for ‘tailored controls’ on wages, taking us back to the failed incomes and prices policies of the 1960s and 1970s.

Monetary tightening designed to squeeze inflation out of the system can lead to a recession and a temporary increase in unemployment. But imposing price and wage controls will likely lead to a far worse outcome: lower economic growth because markets can no longer function well, structurally higher rates of unemployment, and higher inflation because policymakers fail to recognise the root cause of the problem.

The truth is that the pandemic has left us with too much demand and too little supply. It’s time to wake up to that reality.

First published 24th January 2022.

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