The Price Is Right: Setting the Record Straight on Price Controls and Inflation

Quoting economist Alex Tabarrok, editor Ryan Bourne wisely notes that, “Prices are a signal wrapped up in an incentive.” By this he means market prices convey information about scarcity as well as the nature of consumer wants. Prices also incentivize companies to produce what people value, and individuals to conserve where resources are in short supply. Biden’s junk fee policies fail to recognize this important coordinating mechanism of prices.

Tying the Invisible Hand

Whereas it used to be conventional wisdom that binding price ceilings cause shortages and price floors cause gluts, price controls are now suddenly back in vogue. The book’s release coincides with an alarming shift in the regulatory environment. In 2023, for example, Biden’s Office of Management and Budget (OMB) repealed a section of its guidance to federal regulators that discouraged agencies from enacting price controls and similar “economic regulation,” like quotas. OMB’s move will make it easier to impose such policies in the future.

While the ill effects of price controls are sometimes readily apparent, as with the gas lines associated with the 1970s and the rationing of everyday consumer goods during World War II, harms can be harder to detect in other contexts, which explains some of their renewed popularity. Michael Cannon points out in his chapter on healthcare markets that government-fixed healthcare prices are often capped too high relative to the market-clearing level, resulting in excessive spending, the cost of which is largely obscured because it is paid for by government. Meanwhile, controls on financial product prices make it harder for marginal communities, like the poor, to access credit. Reduced access to loans for purchasing homes or vehicles, and higher interest rates on credit cards and mortgages, are not nearly so visible as long lines at the pump.

Other effects of price controls can be hard to anticipate. Bourne’s chapter on World War II price controls documents how, beyond creating shortages, price caps degraded quality in unexpected ways as companies responded to lower revenues. Likewise, Jeffrey Clemens’s chapter on the minimum wage shows how workplaces often cut fringe benefits before adding workers to the unemployment lines, suggesting the real world is messier and more complicated than Econ 101 theory sometimes implies.

Monetary Myths and Misconceptions

In addition to covering the problems with price controls, The War on Prices serves as an excellent primer on inflation and its underlying causes. Bryan Cutsinger rightly criticizes the “wage-price spiral” economic fallacy, which posits that workers pushing for higher wages drive businesses to raise prices, which leads workers to demand still-higher wages in a self-perpetuating inflationary cycle. Brian Albrecht points out how “greedflation” similarly confuses cause and effect. Inflation is fundamentally a monetary phenomenon caused by excess money growth. Inflation drives up nominal corporate profits, not the other way around.

Author Stan Veuger provides a helpful overview of Modern Monetary Theory (MMT), which is a relatively new economic theory “born” in the blogosphere. MMT’s emphasis on the importance of money parallels the monetarist views of some of the book’s contributors. MMT argues, correctly I would say, that monetary policy can in theory be loosened through Congress spending new money into the economy, and tightened by raising taxes. But in practice, policy will never work this way.

The problem with MMT is not so much that the theory is wrong, but that it ignores the political realities that make the use of fiscal policy to control inflation unrealistic. Politicians are usually reluctant to raise taxes for fear of losing the next election. Even if taxes could be raised by exactly the right amount at exactly the right time (a big assumption when Congress can’t pass a budget on time), politicians would need to resist spending the raised revenue to keep inflation in check, and they are unlikely to exhibit any such spending restraint.

As far as areas for improvement, some of the book’s contributors pin blame on journalists for the public’s economic ignorance regarding inflation. Pierre Lemieux, for instance, lambastes journalists who discuss inflation as “driven” by the rising prices of different product categories in the Consumer Price Index (CPI). Price indices have well-known limitations, and Lemieux is correct to point out the shortcomings. But a few of Lemieux’s complaints come across as capricious. Journalists are technically correct when they note that the prices of particular goods, like eggs or milk, do “contribute” to an index rising in value. Even if these journalists sometimes use sloppy language that could be misunderstood as implying a cost of living index and inflation are the same thing, it is unclear how influential these news stories are. In spite of the imperfections with indices like the CPI, they remain useful for tracking overall price trends and detailing the way in which inflation affects different parts of the economy at different times.

The Limits of Laissez-faire

While The War on Prices does a thorough job explaining the virtues of market prices, it did miss the opportunity to discuss some of their downsides. The incentives market prices provide, for example, are often perverse, as when externalities and other market failures are present. In such cases, prices may encourage redirection of production away from efficient uses.

A good example is the high salaries of sports stars, which Deirdre McCloskey defends, but there remain reasons to be skeptical of this free market outcome. Even if those salaries are ultimately the result of intense consumer demand for sports entertainment from athletes exhibiting rare physical ability, society would be better served if consumers had other priorities beyond sitting on the couch watching sports and young people invested their time building more productive forms of human capital. McCloskey is correct to note that market prices don’t tell us anything about what one inherently “deserves.” But a lot of market prices reflect a desire on the part of the public to engage in conspicuous consumption. It would be more economically efficient if we lived in a world where scientists and engineers were as highly valued as actors and athletes are in our own culture.

Price controls also have certain benefits. Consider that if controls enacted during World War II created additional capacity for military production, why would not similar restrictions in normal times create capacity for other valuable items that usually go underproduced? Sacrifice—in the form of consumers accepting lower quality and quantities of consumer goods, as occurs under some price control policies—has upsides. This is especially true when the sacrifice flows from consumers’ free choices to save and invest more and consume less.

The Objective Nature of Subjective Value

The book’s section on value was also a bit light on details when it came to distinguishing between the determinants of value and economic cost. Value derives from individual preferences, and is therefore “subjective” in the sense that the value of a painting might vary from person to person and depend on mental considerations. But the real resources government interventions use up in the form of land, labor, and capital are objective phenomena.

In this sense, economists’ use of the word “subjective” when describing resources’ value can be misleading. Private (individual) and social (total) economic cost are objective concepts falling in the realm of positive economics. Cost can be calculated scientifically, though this does not mean it is always easy to do so. An objective understanding of cost does not negate marginalist or preference-based explanations of price determination. This fact is perfectly consistent with criticisms of the “labor theory of value,” which 19th century economists William Stanley Jevons, Léon Walras and Carl Menger utterly demolished. Yet many economists to this day mistakenly conflate objective cost with subjective accounts of price formation. The chapters on value in The War on Prices thus missed an opportunity to set the record straight in this regard.

Whatever the shortcomings, which were minor, The War on Prices remains essential reading for anyone seeking to understand the economics of price controls and inflation. McCloskey’s core recommendation is spot on. Market failures occur because of missing markets. “The socially sensible move then is to create markets where there are none, not abolish them by collectivization or price controls.”

The challenge lies in promoting the creation of new markets, while still subjecting them to the ethical constraints and related prerogatives that are inescapable for human flourishing. Ultimately markets must be subordinated to certain inalienable checks, such as rights or the protection of “sacred goods” like happiness or aesthetic beauty. McCloskey acknowledges the need to “choose properly what is for sale and what is not,” respecting the role of sacred values.

Overall, The War on Prices arms readers with the intellectual ammunition needed to combat misguided inflationary policies and price controls. It falls short of being able to declare total victory for the free market, however, leaving room for further discussion about the limits of guiding markets by the preferences of indulgent consumers, and the ethical considerations that necessarily factor into governing even the most well-functioning and efficient of market forces.

Footnotes

[1] Ryan A. Bourne (ed.), The War on Prices: How Popular Misconceptions About Inflation, Prices, and Value Create Bad Policy. The Cato Institute, 2024.