I am opposed to the imposition of wage/price controls. As we saw in the early 1970s, they are a terrible idea. Nonetheless, there is an argument for wage/price controls. But it’s not the argument that most of its supporters or opponents might assume.
Wage/price controls cannot stop inflation, which is caused by monetary policy. What wage/price controls might be able to do is prevent high unemployment. The real purpose of wage/price controls is to boost employment, not to reduce inflation.
Suppose you believe (as I do) that nominal wages are sticky in the short run. In that case, a monetary policy that sharply and unexpectedly reduces inflation may lead to a temporary period of high unemployment, until wages adjust to the lower level of nominal spending. In that policy environment, controls on wages might, and I emphasize might, be able to prevent the tight money policy from causing high unemployment.
Notice that I mentioned wage controls, not price controls. The dirty little secret of wage/price controls is that the government’s actual objective is to control wage growth, and the price controls are a fig leaf added to make the policy seem more “fair”, thus making it more politically feasible. The UK government was more honest than most, calling them “incomes policies”.
So why don’t wage/price controls work in the real world? Because they only work if you assume a competent and well-intentioned government, and if you had a competent and well-intentioned government then you never would have had the high persistent inflation in the first place.
Thus in 1971, the corrupt Nixon administration tried to juice the economy with expansionary monetary and fiscal policy in order to get re-elected in 1972, and then simultaneously imposed wage/price controls to delay the adverse effects of this stimulus until after the election.
If you have a credible 2% inflation target, then there is absolutely no benefit to wage/price controls. If you don’t have a credible monetary policy, then wage/price controls won’t solve your problem.
READER COMMENTS
Andrew_FL
Jan 5 2022 at 2:17pm
Wage and price controls can interfere with the measurement of inflation, if they’re very extensive, as happened during World War II. I forget where/when but I believe Milton Friedman compared this method of fighting inflation to fighting a fever by breaking the thermometer.
Scott Sumner
Jan 5 2022 at 3:18pm
That’s right. It doesn’t stop inflation. At best it reduces unemployment (and even on that point I’m skeptical for reasons explained in the post.)
Arqiduka
Jan 5 2022 at 5:31pm
Never thought about it that way but stands to reason.
High unemployment-》 inflation to lower real wages-》 unions get a sniff of the game and ask for higher increases -》 institute wage controls plus fig leaf.
Will freeze relative (nit just absolute) wages though, so will introduce inefficiencies. Would probably work best if enacted with clear short-term sunset provisions.
Mark Z
Jan 5 2022 at 6:17pm
Wouldn’t the price controls have to be explicitly wage controls? That is, price controls on goods and services would not necessarily amount to indirect wage controls, because the same reasons that prevent employers from lowering wages (like worker morale) aren’t solved by price controls; an employer may still react to a price control by just laying people off instead of lowering wages. For this to reliably work, you’d have to come right out and specifically control wages. I guess you could control both, but one would have to keep wages down relative to prices for it to work, which I’m guessing people would notice and not like.
Scott Sumner
Jan 6 2022 at 1:20pm
Nixon’s policy was explicitly wage controls.
Mark Z
Jan 6 2022 at 3:49pm
I’m surprised he was able to do that without suffering an intense backlash. I don’t think a politician today could get away with imposing wage controls (except maybe on very high earning jobs).
Jose Pablo
Jan 6 2022 at 4:22pm
I don’t think a politician today could get away with “allowing” the Central Bank to rise interest rates and, at the same time, this same politician tightening fiscal policy to the extent required to cover the aditional interest expenses and then some more to make the public believe they are actually going to repaid (or at least reduce) the debt …
… which is, I think, the same as saying that I don’t think a politician today can control inflation.
Scott Sumner
Jan 8 2022 at 10:13pm
Many liberal economists and politicians supported wage controls.
Jose Pablo
Jan 5 2022 at 6:21pm
“inflation, which is caused by monetary policy.”
isn’t it by “fiscal policy”?
https://www.economist.com/finance-and-economics/2021/12/18/has-the-pandemic-shown-inflation-to-be-a-fiscal-phenomenon
https://johnhcochrane.blogspot.com/2022/01/fiscal-inflation.html#more
Scott Sumner
Jan 6 2022 at 1:21pm
There is a mountain of evidence that monetary policy dominates fiscal policy. That’s why the Fed was given the responsibility of targeting inflation, not Congress.
Jose Pablo
Jan 6 2022 at 1:35pm
Yes, but …
Cochrane seems to disagree.
https://johnhcochrane.blogspot.com/2021/11/grumpy-on-inflation-at-cato.html
Obviously, everything matters (as always when we don’t have a good theory), but we don’t seem to have a consensus even on what dominates what …
… or in what is monetary and what is fiscal policy for that matter.
Sentences full of “ifs” and “buts” are always a hard reading …
Scott Sumner
Jan 7 2022 at 12:41pm
I have yet to see anyone make a persuasive case that the FTPL applies to the US. The data all points in the other direction.
Jose Pablo
Jan 7 2022 at 12:59pm
So, do you believe that a tightening of the monetary policy is all is needed to curb inflation? even in an scenario or simultaneous expansionary fiscal policy?
Or do you think, with Cochrane, that a fiscal tightening would be required at the same time? (and, even, some “structural reforms” that can produce growth).
There is a big difference since as you point out, only monetary policy is settled by a (more or less) independent body.
Scott Sumner
Jan 7 2022 at 2:16pm
“So, do you believe that a tightening of the monetary policy is all is needed to curb inflation? even in an scenario or simultaneous expansionary fiscal policy?”
In the US? Yes, that’s all it would take.
Thomas Lee Hutcheson
Jan 6 2022 at 1:25am
I think the respectable case for price controls is to change expectations about inflation and thereby to increase the demand for money, which, given money supply, is disinflationary. I don’t think it works, but it’s a good theory.
Arqiduka
Jan 7 2022 at 4:00am
Surely one must factor in the fact that price controls create real shortages, hence won’t necessarily affect demand for money. An issue not present with wage control since we are postulating a labor glut from sticky wages already.
Jose Pablo
Jan 6 2022 at 1:08pm
The main function of price controls is allowing governments to show they are doing “something” about inflation. And that’s an irresistible feature. You can bet price controls are going to be with us forever. No matter what the consensus among economists (is such a thing exists) about its usefulness is.
Same thing with tariffs.
Same thing (just upside down) with Pigouvian taxes to curb CO2 emissions.
I would start to devote time to understand why the people in charge of understanding how the economy works keep talking about how it “should” work … in the galaxy far far away that they use to “represent” our world.
It’s akin to a zoologist explaining to the turtles that they should lay their eggs closer to the shoreline. Or, borrowing the image from Taleb, teaching birds how they “should” fly.
Jose Pablo
Jan 7 2022 at 10:36am
https://www.economist.com/leaders/2022/01/08/democrats-seem-drawn-to-hare-brained-schemes-to-control-inflation
And sure enough, the Biden administration favors price controls and Elizabeth Warren (an economist) wants to control “profit margins” (does this count as a form of “price control”?).
And sure enough, Isabella Weber (an economist at the University of Massachusetts Amherst) wants “a systematic consideration of strategic price controls”, which sounds to me like an euphemism for “pure price control”.
And Todd Tucker says:
Selective price controls on these products could be a way to guard against price gouging by producers of goods and help consumers.
https://rooseveltinstitute.org/publications/price-controls-how-the-us-has-used-them-and-how-they-can-help-shape-industries/
Granted he is not an economist, is a “political scientist”, which sounds oxymoronic to me but …
I don’t know guys … get your “scientific models” together …
vince
Jan 10 2022 at 12:01am
Jose Pablo wrote: ” Elizabeth Warren (an economist) wants to control “profit margins” …”
Warren is not an economist. She is an attorney. Don’t feel bad, Jose, Warren was wrong too. She claimed to be an Indian on her Texas law license. She isn’t.
Jose Pablo
Jan 10 2022 at 8:57pm
Thanks Vince! … I was convinced she was an economist by training.
Now that you point out my mistake, I realize it’s coming from watching her presentation at Berkeley, back in 2008, about “The Coming Collapse of the Middle Class: Higher Risk, Lower Rewards and a Shrinking Safety Net”. One hour on the evolution of prices during the last 30 years. She certainly has strong opinions on economic issues.
My bad.
Craig
Jan 8 2022 at 12:20pm
Nothing new under the sun. Emperor Diocletian propounded the Edict on Maximum Prices back in 301 AD just as the crisis of the second century was coming to a close. Bottom line of course is that the Roman state wanted to spend more than it was taking in and it found it expedient to debase the coinage constantly and consistently to the point where a denarius was about 5% of the silver it had been back in the earlier days of the empire.
As Madison noted in the Federalist papers: “In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself.”
We see time and again that governments simply will not be obliged to control themselves and this lack of fiscal restraint ultimately gets financed by inflation which the government then has the chutzpah to blame on people actually producing the goods.
Matthias
Jan 9 2022 at 1:25am
What makes you think that a spendthrift government always results in inflation?
I can see an argument that a spendthrift government sometimes or even often result in inflation. But I don’t see the argument for always.
Especially since you suggest that inflation will finance the spending in the end. Instead of bankruptcy for example.
Many spendthrift governments borrow in foreign currencies (or, in the past, in gold), so can’t use inflation.
Matthias
Jan 9 2022 at 1:26am
That should probably be bankruptcy and/or other forms of default.
Philippe Bélanger
Jan 10 2022 at 12:16am
I don’t understand how wage controls could prevent unemployment under a tight monetary policy. A fall in aggregate demand reduces the demand for labor, which raises unemployment if wages are sticky. A wage freeze could only further reduce employment, by reducing the quantity of labor supplied.
Richard W Fulmer
Jan 12 2022 at 5:59pm
I think that the idea is that companies will want to reduce wages when they see the prices that they can command for their goods falling. But businesses are reluctant to cut employee pay because it’s bad for moral (hence “sticky wages”). A wage freeze would, at least, halt any wage increases that are already in the pipeline (the assumption here is unexpected deflation or drop in inflation, so COLAs might have been triggered before the drop occurred).
You’re suggesting that, while a freeze might help maintain the demand for labor, it could reduce the supply – that is, the willingness of workers to continue work without pay increases.
I wonder if a freeze would be sufficient to maintain demand for labor. With a sudden deflation, industries that were booming because of the previous inflation (e.g., housing, automobiles, capital expansion) will see a downturn. Meanwhile industries with inelastic demand (healthcare, consumer staples, transportation) will be largely unaffected or may actually get a bump.
An across-the-board wage reduction might help maintain demand for labor better than a freeze. Also, because it’s mandated by the government, there would be no employee backlash against employers.
However, demand for labor would likely shift between sectors in the economy. It follows that wages should go down in some sectors, stay the same in some, and perhaps even rise in a few. Any attempts at wage controls – either with a freeze or an across-the-board reduction – would slow the necessary adjustments and prolong the agony.
Richard Fulmer
Jan 12 2022 at 5:23pm
When you talk about wage controls to prevent layoffs during a period of unexpected deflation, you’re talking about the government dictating a reduction in wages, right? What politician would order such a thing and, if he did, would he survive the next election?
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