When and How to Use Price Controls, Isabella Weber?

There have been multiple unconventional attempts to deal with the price shock after the pandemic and Russia’s invasion. One of them are price caps. However, controlling or capping prices is one of the most contested policy tools under economists, as prices are usually seen as the most efficient coordination tool to balance demand and supply. This logic certainly applies to functioning markets, but what about emergencies in which demand and supply behave abnormally?

When and How to Use Price Controls? This was the topic of our last session at our XII New Paradigm Workshop with Isabella Weber (University of Massachusetts Amherst), and Anatole Kaletsky (Gavekal Dragonomics). As an opening remark, Isabella Weber observed that we are living in a world of overlapping emergencies, which makes disaster preparedness key to deal with potential next shocks. Using as analogy the snow storm ‘Elliott’ hitting NYC in December 2022, Weber underlined that neither demand and supply behave normally in times of crises. Rather there is an abnormal market disruption: High demand of certain essential and vital goods meets a shortage of supply, giving sellers a lot of pricing power (which they do not have in normal times).

How does this relate to more general cases such as a pandemic or a war? Weber emphasised that price controls have not always been dismissed by the mainstream economics profession. After World War II, some of the most distinguished American economists of the 20th century (Paul Samuelson, Irving Fisher, Simon Kuznets, etc.) called for a continuation of price controls. They argued that as long as bottlenecks made it impossible for supply to meet demand, price controls for important goods should be continued to prevent prices from shooting up.

Of course, as Weber made clear, price controls will neither stop inflation nor solve the structural supply side problem. But you prevent a situation where firms take unfair advantage of a crisis situation. In this manner, they should be used strategically to gain time for other measures to directly address the supply bottlenecks.

What about long-term signals of high prices, which should raise supply in areas with high mark-ups? Isabella Weber illustrated with firm level evidence that this may not have been the case in recently supply-constrained sectors, as firms had both the incentive and the power to constrain supply and thereby raise profits.

The key message of Weber’s presentation was that price caps are the ultima ratio to deal with supply chain shortfalls and should be implemented in high inflation risk sectors, which can be identified for example by input-output analysis. These sectors for the US economy include basic necessities (housing, food, etc.), basic production inputs (oil and gas, chemicals, etc.), and basic circulation (wholesale trade, transportation). Policies designed to correct supply shortages could absorb price shocks and prevent a propagation and amplification in other sectors, as well as the resulting conflict (inflation) between labor and capital over real wages.