Can Price Controls Fight Inflation?

In recent years, fears of inflation and the possibility of recession have grabbed headlines, particularly as the Federal Reserve has raised interest rates to curb inflation. In a recent article published in The Washington Post, historian Meg Jacobs and economist Isabella Weber suggest an alternative way to fight inflation.1 Rather than fight inflation by raising interest rates and risk the potential of a deep recession, Jacobs and Weber argue that implementing price controls would be a more effective means of curbing inflation. As they argue, although “price controls have a bad reputation politically and a record of mixed success, they worked in one of the most important cases in American history—World War II. And the differences between that case and later failures,” such as Nixon’s implementation of wage and price controls during the 1970s, “reveal how policymakers can wield this tool effectively.”

Whether or not price controls “work” to fight inflation, the question has broader implications for our understanding of basic price theory. As I argue below, the only way in which price controls “work” to fight inflation is under the premise that prices provide marching orders to solve a technological problem. However, the real function of prices is to provide guiding signals to solve an economic problem of allocating scarce resources according to their valuation in competing consumer uses. My point is not to argue whether Jacobs and Weber are unaware of this distinction, per se. Rather, it is to illustrate, from their own point of view, the only way in which their argument “works”, namely the claim that price controls can fight inflation.

The fundamental nature of a technological problem is the allocation of given resource for a single, given objective. In the context of World War II, the Office of Price Administration and Civilian Supply, which was created in 1941, and succeeded by the Office of Price Administration (OPA) from 1942 to 1946, effectively abolished free market pricing for all goods and services. Although the United States did not officially abolish private property rights during this time, in effect, price controls constituted a restriction on the ability to exchange on mutually agreeable terms, and hence a de facto restriction of private property.

In effect, the de facto control of the factors of production (i.e. land, labor, capital and other means of production) through price controls administered by the OPA and other government agencies replaced a free market and militarized the U.S. economy for a single, overriding purpose: to defeat the Axis Powers. In a situation of total war, however, the valuation of factors of production are not derived from competing valuations between consumers for final goods and services. Rather, the goals and plans of individuals (consumers and producers alike) are superseded by a technological problem: the allocation of resources toward destruction of the enemy. As Friedrich A. Hayek elaborates on this point:

  • The problems which the director of all economic activities of a community would have to face would only be similar to those solved by an engineer if the order of importance of the different needs of the community were fixed in such a definite and absolute way that provision for one could always be made irrespective of cost. If it were possible for him first to decide on the best way to produce the necessary supply of, say, food as the most important need, as if it were the only need, and would think about the supply, say of clothing, only if and when some means were left over after the demand for food had been fully satisfied, then there would be no economic problem. For in such a case nothing would be left over except what could not possibly be used for the first purpose, either because it could not be turned into food or because there was no further demand for food. The criterion would simply be whether the possible maximum of foodstuffs had been produced or whether the application of different methods might not lead to a greater output (emphasis added, 1935, p. 5-6).

On the contrary, the lessons that Jacobs and Weber claim to be drawing about the role of WWII price controls are irrelevant to the issue of controlling present-day inflation, since their example of “success” assumes away the role that market prices play in solving an economic problem: allocating scarce resources among multiple, and often conflicting, consumer uses. “The key to price stabilization,” Jacobs and Weber argue, “lies in politics: a strong alliance and a broad-based social commitment are crucial for the effective implementation of selective controls as a way to tamp down inflation.” However euphemistic such government control may sound, it cannot hide the fact that prices are presumed here to function like a set of marching orders decreed from the top down to which individuals passively respond in fulfillment of a single, overriding end.

My point here is not to argue that inflation was actually controlled during World War II, as Jacobs and Weber claim. Rather, it is to argue that the only way in which the validity of Jacobs and Weber’s argument can hold is if consumers and producers are presumed to have been dictated prices in a completely passive manner. This implicit assumption not only renders the argument inapplicable for remedying inflation today, but also proves unsound in the case of World War II, since the discussion of the secondary effects of price controls are completely absentSimon Kuznets, Nobel Laureate in Economics for his work on the measurement of GDP, explained following the conclusion of World War II in his book, National Product in Wartime. He argument then expresses serious doubts relevant to Jacobs and Weber’s claims today, and applies just as much about the prospect of price controls controlling inflation today:

  • Price indexes do not reflect fully qualitative deterioration in commodities and services; the ‘pricing up’ that takes the form of adding superficial and unwanted elements to the good, largely in order to raise it into higher price brackets without violating price regulations; the reduction in discounts or in services formerly granted in connection with durable commodities; pricing on black markets; and the general effects of a narrowing freedom of choice on the part of would-be civilian purchasers (Kuznets 1945, p. 39).

What Kuznets is highlighting is the adjustment process that prices generate in a situation where there is relatively more money competing for relatively fewer goods (i.e. inflation). Consumers for final goods will compete against each other by offering higher prices, and in turn, producers of such final goods (i.e. consumers of scarce resources) will compete against each other by offering higher prices in response to such consumer valuations. If prices are not allowed to respond to such competing demands to solve this economic problem because price controls are implemented, then the results outlined by Kuznets above will result.

In summary, to conclude that price controls are an effective means to combat inflation is incorrectly based on an unrealistic and faulty understanding of prices as a set of marching orders to which individuals passively respond. However, prices in the real world are actively generated by competition between consumers for goods and services, and competition between producers for factors of production. The result is that market prices serve as a set of guides, or traffic signals if you will, to coordinate the plans of consumers and producers in a peaceful and productive manner. If prices serve as a “system of telecommunications” as F.A. Hayek taught us (1945, p. 527), then interference into the guiding function of market prices can never eliminate inflation; rather, relative prices will only adjust to account for inflation and circumventions to price controls.

Original Article: