Price Controls Are No Answer for Soaring Prices

With consumer prices soaring 7.9 percent in the past year to a height not seen since 1982, some economists have recently turned for solace to the siren song of price controls. For example, Isabella Weber of the University of Massachusetts Amherst and Todd Tucker of the Roosevelt Institute have both recently written op-eds arguing for price controls as one solution to our economic woes. This is misguided. Price controls would be a huge mistake.

Let’s use the example of gasoline to see why: Average gasoline prices in the US are a little over $4 per gallon right now. That’s higher than they’ve ever been. What if we passed a law saying that gasoline cannot be sold for more than $2 per gallon, the price back in spring of 2020?

At $2 per gallon, there are a lot more people that want to buy gasoline than at $4. There would also be very few retail gas stations willing to sell gas at a loss, since they are paying close to $4 per gallon from their suppliers. Why would they sell it for $2? So, refiners would produce less gasoline and more of other products that use crude oil, like jet fuel, heating oil, or plastics. The result is a classic economic shortage. Americans that remember the 1970s saw this play out in real life, as price controls on oil led to shortages at the gas pump. Waiting in line for gasoline became an unfortunate ritual for Americans, much like in permanent shortage economies such as the Soviet Union at the time.

What the Soviet Union missed by artificially capping prices was the crucial information prices convey in a market. As Nobel Laureate F.A. Hayek explained, prices give information to consumers. A high and rising price tells consumers that a good is scarcer than it was in the recent past. A consumer need not know why it is scarcer, and Hayek said this was one of the main benefits, as prices give us the information even if we don’t know why something is happening. All consumers need to know is that they should buy less of the good.

But what do we do when all prices are rising, as they are today? The only possible response is to cut back on purchases across the board. This situation spells ruin for household budgets and it’s not sustainable. So, if not price controls, what should be done?

For one thing, the Federal Reserve should act quickly to get a handle on inflation that’s ravaging the country. Economists focus on two main reasons for current rates of inflation. First, the money supply was greatly expanded during the early months of the pandemic, both to provide support to individuals, businesses, and the financial sector. More money circulating in the economy means prices must rise. Second, the economic impact payments, or “stimulus checks,” given out over the past 2 years have given consumers increasing spending power. This spending power certainly helped individuals and families respond to the pandemic, but the aggregate effect on the economy is an increase in demand for goods, which take time to produce, time to ship, and inputs that are suffering from the same increase in demand.

Ever heard a politician, an economist or a customer service rep talk about “supply chain issues”? This is what we’re talking about: More people want to buy more stuff than ever before in US history.

The Federal Reserve has already started to raise interest rates, which should slow the growth of the money supply, and they should continue this policy response. But discussion of future stimulus payments, whether from the federal government or from states to offset higher gas prices, will only add further fuel to the fire of inflation.

Inflation is the messenger: Our monetary and fiscal response to the pandemic has caused too much spending in the economy. The way out of this mess is to refrain from repeating the policies of the past 2 years.

Jeremy Horpedahl is an associate professor of economics at the University of Central Arkansas and a research scholar at the Arkansas Center for Research in Economics.