At the end of 2021, The Guardian published one of my first newspaper commentaries, in which I criticised the rush to use interest-rates hikes to combat inflation and reminded my readers of the history of a long-neglected alternative: strategic, targeted price controls. At the time, this was judged to be an act of heresy.
The history of price stabilisation goes back centuries, from the mists of classical China (my own research focus) to the major crises of the past century: World War II, the Korean War, and the stagflation of the 1970s in the United States. In each case, price-stabilisation policies served as emergency measures aimed not just at “fighting inflation,” but at doing so in a fair and socially stabilising manner. Their primary purpose was to attack profiteering (from wars, famines, and disasters) head-on. They have tended to work in highly concentrated markets, and when implemented before inflation spirals out of control, while performing poorly otherwise. And when carried out in democratic societies, through a mobilisation of the population behind a common project of price restraint, they have been massively popular – especially when weighed against the alternative of austerity.
But by late 2021, that history had dropped out of the common sense of economics. My intervention hit a nerve. Right-wing and libertarian social media erupted in fury, and even many liberal and progressive economists found strong words to reject my intervention. At the University of Chicago, students received an exam asking what a “real economist” would say about price controls. To my detractors, a company’s right to set any price that it can get away with (“whatever the market will bear”) was sacrosanct. Price hikes had to be endured if we wanted them to go away sooner rather than later. If a policy response was warranted, the only way to address rapid price increases was either to wait it out or impose high interest rates, even though these ultimately would crush small businesses, workers, and indebted households. “There is no alternative” – or so they said.
From theory to practice
In February 2022, my colleague, Sebastian Dullien, and I set out to establish that there are indeed feasible alternatives to macroeconomic tightening. We proposed a fiscally financed price cap on basic household consumption that would preserve market prices at the margins. This led to another round of criticism from economists. But our proposal also received strong endorsements from a wide range of interest groups.
Fast forward to September 2022, when I found myself appointed to a German government commission charged with designing a price-stabilisation policy to address the energy crisis following Russia’s invasion of Ukraine. There, we developed the so-called “gas-price brake,” and the key principles that I had been advocating were subsequently enshrined in German law.
Germany is not alone in implementing a price policy. Across Europe (and in the United Kingdom), governments have implemented various forms of price controls to contain the war’s fallout in global energy markets. The European Union has enacted a gas-price cap, the G7 has imposed a price ceiling on imported Russian oil, and the US government has leaned on the price of oil by releasing supply from its Strategic Petroleum Reserve.
Moreover, leading economists have rushed to endorse selective, targeted price controls. By January of this year, Paul Krugman of the New York Times, for example, was suggesting that it might not be so foolish after all to respond to price explosions with price policies, even though he had criticised this approach earlier. (It remains to be seen whether the University of Chicago will be revising its exam.)
As my co-authors and I illustrate in a new working paper, sectoral bottlenecks and price shocks in systemically significant sectors, especially oil and gas, played a major role in today’s inflation. As prices rose, so did many profits, creating effects that have since reverberated through the economy as other sectors scrambled to make up for higher costs, and as workers demanded cost-of-living adjustments. Now that a previously stable system has become unstable, higher interest rates can only add fuel to the fire. That is why it is so important to avail ourselves of more socially acceptable alternatives.
Consider the US. During the pandemic shutdowns, when oil prices were collapsing, producers closed their highest-cost wells. But when demand recovered, the recovery in supply lagged. Producers saw that they could keep costs down and prices up by leaving the less-productive wells closed. The result was a massive windfall. Gasoline prices briefly hit $5 per gallon, on average, and the fossil-fuel industry’s profits broke new records.
In this type of situation, an oil-producing country can pursue selective price controls – without even resorting to fiscal transfers. Far from hindering production, this approach can spur higher output. As long as a price policy assures a sufficient margin per barrel, producers will find that producing more is the only way to earn a higher gross profit. This is the dirty secret that most economists have refused to acknowledge, but which practical price fixers have discovered time and again. If done right, a price-control policy’s effect on output can be the opposite of what textbooks predict.
Of course, things get more complicated when you are dealing with economic warfare. Whereas a Texas oilman is in the game for one reason, Russia has other objectives aside from money. Following the G7’s and EU’s decisions to cap the price on imported Russian oil, the Kremlin responded by threatening to cut output. Whether it will do so, or by how much, remains to be seen, given its dependence on revenues from hydrocarbons.
Another complicating factor is climate change. One might ask whether it is even desirable to bring down the price of fossil fuels, given the need to accelerate the shift to renewables. On the other hand, consumers and many businesses face serious constraints when it comes to changing their consumption patterns radically in the short run. Tragically, the same communities that are hit hardest by both climate change and fossil-fuel pollution are also among the main victims of oil-price shocks.
Fortunately, combining a price cap with a sufficiently high marginal price, as the German gas-price brake does, can both preserve production incentives and protect basic consumption needs from a price shock. It also prevents the kind of explosive fossil-fuel profit growth that we saw last year. By making Big Oil more attractive to investors (compared to renewables) and strengthening the vested interests that have long denied that human activities have spurred climate change, such windfalls are counterproductive for an urgently needed green transition.
A new stabilisation paradigm
The new openness toward the strategic use of targeted price controls is welcome, because it acknowledges that inflation is not always purely macroeconomic in origin. Managing the kinds of micro shocks in essentials that we have suffered in recent years requires expanding our toolbox of stabilisation policies. A window for new policy thinking has opened; there is a bit of fresh air coming in. Now that we have dispensed with old shibboleths, we can take another look at economic history to reconsider conventional wisdom and develop fast, fair, effective ways of managing new kinds of economic instabilities.
A new stabilisation paradigm is urgently needed. We are living in a world of overlapping emergencies – climate change, a pandemic, mounting geopolitical tensions – and more shocks are sure to come. Policymakers need to be prepared to react before price shocks ripple through the whole system again, leaving inflation and widespread social and economic harm in their wake. Such efforts must focus on the sectors that matter most. As my co-authors and I show, an input-output analysis can be used to identify systemically significant prices, thereby helping policymakers prepare for future emergencies.
In an age of radical uncertainty and disruptive change, economics must move beyond the old playbook. There are no ready-made solutions or magic bullets that will solve the unprecedented problems we face. For economics to be part of the solution, it needs to remain amenable to more ideas, old and new. To confront the enormous economic-policy challenges of our time, there can be no substitute for a culture of openness toward different approaches.
*Isabella M. Weber, Assistant Professor of Economics at the University of Massachusetts Amherst, is the author of How China Escaped Shock Therapy: The Market Reform Debate (Routledge, 2021). Copyright: Project Syndicate, 2023, published here with permission.
53 Comments
'sectoral bottlenecks and price shocks in systemically significant sectors, especially oil and gas, played a major role in today’s inflation.'
No kidding.
I suspect, she doesn't understand the ramifications of this powering-down, but she is absolutely right, in the last two paras. We have moved outside the parameters of the economic playbook.
Hi PowerDownKiwi.
What you post about regularly makes perfect sense to me. I was just wondering... If the Energy Return on Investment of digging up a fossil fuel source is low or negative it will stay in the ground. If that fuel source is dug up and used to build renewable energy systems (which ultimately still rely on fossil fuels) can this create a better energy efficiency thus raising the Energy Return on Investment?
In short: Can renewables ironically make it more economically feasible (in an energy sense) to dig up more fossil fuels?
Fantastic question.
In physics terms, the need is to build, or adapt, our energy infrastructure to be able to exist long term. That's it. That's the goal.
If renewables can ONLY be built using fossil energy, they don't quality. They will have to be built by themselves. Yes, we can - presumably will - build the first round using FF, but if solar panels cannot power the building of solar panels.......... then we are looking at a stop-gap (the life of a decaying panel, say 25-39 years).
Yes, we will be building whatever we build - Onslow comes to mind - using FF. Whether we can maintain the grid, post FF, is the bigger (and currently being unasked) question.
When energy hits an EROEI of 1:1 or lower, it will never be used, never dug up. Economists don't understand this; they believe the making of money somehow produces whatever you want. The bigger problem comes as you approach 1:1 - down around where we are now, and lower, the economic system goes further and further into debt, stranding more and more of the forward bets (pension expectations, for instance). It may well cave in - collapse - which will render the above 1:1 remainder, un-extractable (who pays who, ex FOB-type trust?)
Here's an explanation (one hour):
"Economics must move beyond the old play book "
We know that! We knew it as recently as 2008, and nothing changed. Do you know why? Because a relatively few people, who had a lot, would lose a lot. Not all of it by any means, but a lot. And the alternative was to allow a lot of people who had a little, to lose it all
And that will apply to any 'solutions' enacted today. In an economic System of carrot-and-stick when the stick isn't used the carrot gets devoured.
Conclusion? Interest rates are going far higher than most anticipate (or need to go) but that is all that we have that will work. A Big Stick.
Interest rates are going far higher than most anticipate (or need to go) but that is all that we have that will work.
All that we have? Isn't that exactly the point of the article?
We also have tax. The UK has increased taxes on the upper-middle and above so they have less money to spend while the UK Govt has more money to spend paying down debt and rebuilding infrastructure and services.
The time to rebuild infrastructure and services was yesterday (i.e., 2021 and before that). Any money a government spends on an already stretched system amid chronic labour and capital shortages is likely to be inflationary and most of it would find its way back into the pockets of higher-income earners.
Governments squandered much of the easy money era over the last 15 or so years waiting for free markets to fix structural issues in their national economies. Now they are pressing down on the accelerator when it's time to ease up on the fiscal spending.
The current model works if used correctly and everyone is accountable for their actions.
When inflation rises interest rates rise.. IF we all know and expect it and plan accordingly all is good.
If reserve banks dont raise fast enough its a problem. As rates have to go higher faster later in the cycle (as now)
Those that dont plan accordingly (leveraged individuals, banks, regulators, businesses) will fail and lose a lot of money.. their depositors, creditors, etc etc
Its pretty rubbish to complain those people and entities werent ready.. after years of boom and loose monetary policy and with 12-24 months of warnings of possible high rates.... plus multiple boom bust cycles taught to economists and business people for 50 years..
The advantage of usung rates.. is we all know what to expect .
Changing reactions is unnessessary and too complicated
hey - with 30 years spent in high tech industries i am all for new fangled stuff but only where there is merit.
In this case there is a well proven, expected way to solve inflation which is to raise the OCR higher faster - which would solve the problem, and people that managed their risk accounted for that eventuality and wont be affected much if at all - in fact they are almost hoping for it.
the only reason its not being used is the fear of a recession and asset price drop - but again most smart people hedged against those outcomes anyway as they knew that would be the outcome and the reserve banks have been warning to prep for it for 12 months . We are simply not doing it for fear of upsetting the few who mismanaged their risk.. SVB, credit suisse, overleveraged infvetors etc.. instead we heap inflationary pain on the poor.
High tech engineers use a term - KISS ('Keep it Simple ___')... for a reason. It includes the rule to avoid overcomplicated stuff, or to change things that arent broken - without a very good reason. in the same way - the way to solve inflationary problems is to raise the OCR and let those that were foolish learn a lesson .... and those that managed their risk against the anticipated outcome survive.. its how the world works.
Germany is not alone in implementing a price policy. Across Europe (and in the United Kingdom), governments have implemented various forms of price controls to contain the war’s fallout in global energy markets. The European Union has enacted a gas-price cap, the G7 has imposed a price ceiling on imported Russian oil...
Securing essential global supplies will surely trump price controls.
Nobody is claiming their method are 100% effective across the board but there are lessons the West could learn (or re-learn) on the engineering design and project delivery prowess displayed by the Chinese.
The problem has been the CPC trying to do too much too fast to feign superiority and letting their geopolitical ambitions take priority over sound economic management.
One can't help thinking that the underlying message here is that interest rates HAVE to be kept low in order to wring the last ounce of the debt monster that has been created in the last 20 odd years (if not more) as that is the only thing that has kept 'growth' going. As such any and all other avenues (other than actually setting a reasonable level for the price of debt) have to be considered.
Incredible that it's come to this - end stage capitalism begins to eat itself.
When your economy takes money created by bank lending and stuffs it into the pockets of rich people who hoard wealth, yes, you absolutely rely on low interest rates to keep the economy moving. Why? Because if net lending rates fall behind the rate required to sustain jobs and consumption, your economy tanks and thousands of people lose their jobs (see 2023 as a live example). We could all live quite happily without relying on credit money gushing into the economy if we kept the money moving (ie stopped it being hoarded) and only used cheap credit for productivity improvements that enabled us to work less hours for the same output.
But, yes, I agree - capitalism is eating itself!
From the abstract of her recent article;
The sectors with systemically significant prices fall into three groups: energy, basic production inputs other than energy, basic necessities, and commercial and financial infrastructure. Specifically, they are “Petroleum and coal products”, “Oil and gas extraction”, “Utilities”, “Chemical products”, “Farms”, “Food and beverage and tobacco products”, “Housing”, and “Wholesale trade”.
Would love to see an analysis of this sort, and the tools that could be used to achieve price stabilisation with respect to housing/rental accommodation.
The more I look at it, the more I believe we need to act and act swiftly on behalf of 1/3 of our population in rental accommodation. We are on a systemically significant precipice, for sure, as the recent interest rate rises are the last nail in the coffin for many small investors.
And what is the Government doing about managing this shock - naught. They're like a possum in the headlights as there just isn't the paradigmatic thinking in government circles here that the author talks about..
And what is the Government doing about managing this shock - naught. They're like a possum in the headlights as there just isn't the paradigmatic thinking in government circles here that the author talks about..
They are too busy thinking up ways to get votes, more so than the long term stability, social cohesion and welfare of their own country's constituents. We need to build a government full of people with skills of different areas, different backgrounds as well, in order to have a pragmatic and coordinated view of where NZ is heading.
"This is the dirty secret that most economists have refused to acknowledge, but which practical price fixers have discovered time and again. If done right, a price-control policy’s effect on output can be the opposite of what textbooks predict."
"...time and again." ? Any evidence for that blanket assertion in successful countries. The vague reference point given is the wilful supply constraints enacted by US oil oligopoly during the pandemic artificial market to extract windfall profits. Not dissimilar to NZ power generators spilling hydro to increase the electricity spot price.
I well recall NZs price control experiment 40 odd years ago, including concurrent wage/salary fixing. The closest we ever came to communism (under a National government).
The USA's strategic petroleum reserve is an example. One of its core tenants was to introduce price stability.
Warehousing - somewhat out of fashion in our just-in-time supply chains - is another example.
Muldoon's price-controls were un-targeted and poorly thought out. They can not be compared to what Isabella is suggesting.
Increasing warehousing (=increased stock buffers beyond optimum demand/replenishment cycles) won't work in a real business that needs to make a profit - & it will come at significant additional costs including quality & wastage. Particularly now that rising interest rates have increase the cost of working capital.
100% agree with this. The trick though is to act before the price spirals and remove promptly when the control has done its job. And this is hard if we have to rely on politicians to act. Damn hard!
Far better to have a set of tools prepared and ready to go and hand them to some body to call the shots. Much like how we allow an unelected NZRB to act with impunity.
... it does sound as if she's proposing we set up a board who're autonomous from the government , and who'll monitor prices during any given " crisis " , and recommend price freezes where deemed necessary ....
Kind of like the RBNZ , except watching the price of eggs , bread & petrol ... instead of inflation ...
.... remind me , how's that RBNZ thing working out for us .... no problems ?
A Price Stability Authority that took action to smooth out the fluctations in the price of fuel and fertiliser (and maybe some high-use building materials) would be ridiculously popular with businesses and would make a huge difference to production costs and local prices. An authority like this could be cost neutral. It's a no brainer for a little country in pacific that is demonstrably a price taker.
The last three words are invalid.
'than anybody else', is what you should have said.
'the economy' is nothing more than a bunch of people striving to consume more today, than they did yesterday.
A totally artificial, human construct, based on extraction of parts of a finite planet. And the high priests of this self-aggrandizing religion (because it is a belief system, nothing more)? Economists. Who are looking increasingly bewildered, for obvious-to-physics reasons.
The reliance on endless debt enslavement with overshoot bailed out by inflation (socialisation of losses) is not the answer. Lift rates to where they should be. Let the speculative accept the risk they have taken and be eliniminate if needs be (capitalism), and ensure a true cost of capital/debt remains there after.
100% correct. The over-indebted and speculators knew that they were taking a gamble, and if they are going to be punished so be it. The true cost of capital/debt should at the very least be equal to the inflation rate. For example, a neutral OCR now should be at least at 6%.
I like the proposition in principle for managing a cost of living crisis like we are currently experiencing. This is causing real harm to people. On the other side there will be a hell of a lot of resistance from vested interests via their lobbyists to setting such a system up as it threatens profitability threatens the accepted economic mantra.
Inflation has to be tackled as it hurts the lower and middle earners more yesterday got a block of cheese which cost 16.90 was around 11 a year ago food price’s are rocketing up, people living in cars two or three families in one house crime is rampant this is only going to get worse unless inflation is pulled back wages never go up as much as inflation when it is at this level.
Exactly, and tackling inflation has a simple answer.. rapid increase of the OCR and mortgage rates. we all know this. the trouble is (and the reason rates were so low for too long and caused inflation) is that the powers that be are being pressured to keep rates low to benefit the wealthy and overleveraged.
Sooner or later rates will rise. initially rents may try to rise.. but very rapidly as hosue prices crash - then rents will also crash.. and inflation will cease. Which will help the poor and renters.
Its how the system should work - when properly managed. if RBNZ were serious about their one target (inflation) and had incorporated all housing costs into the inflation numbers years ago then none of this would even be an issue.
trying to change how we respond would just be a last ditch attempt to rescue asset prices instead of actually using the hammer properly and nailing inflation
I wonder how high the OCR can go before indirectly causing negative equity in bank's balance sheets. One of the less important "ahem" rbnz mandates is financial stability. I'm no fan price controlls by the way, because they just lead to shortages as far as I can tell.
Name one thing where artificially capping the retail price of something produced more of that something? In most cases, it results in far less of that thing - like rent control eventually results in rental shortages. The way to reduce prices is to produce more of that thing, not less, that's basic Econ 101. As the saying goes "the cure for high prices is high prices".
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.