The United States last year experienced its highest inflation rate in nearly 40 years. Not surprisingly, the public expects the government to do something to get inflation under control. If policymakers hope to deliver, theyll have to address inflations root causes and not paper over its symptoms.
Last years 6.8 percent inflation rate was the highest since 1982. Seventy-two percent of Americans, according to a mid-December CNN poll, say the government is doing too little to reduce it.
As Robert Schuettinger and Eamonn Butler demonstrated in their 1979 book, Forty Centuries of Wage and Price Controls, price controls have been imposed throughout world historyand unfailingly fail. Theyre such a bad idea that left-leaning economist and Nobel Prize winner Paul Krugman called Webers argument "truly stupid" before apologizing for his rude tone.
But Krugmans initial reaction was right. Rising prices are a symptom of an underlying problemnot the problem itself. Using the power of government to limit price increases will do as much long-term good as trying to stop global warming by preventing thermometers from registering higher readings.
Its also important for policymakers to recognize that while the inflation rate is an aggregate measure, not all prices rise equally. Each individual pricefor beef and poultry, gasoline, lumber and plywood, new cars and so forthconveys information about the relative scarcity of specific goods or services. These price signals incentivize consumers to switch to relatively less scarce (and thus, less costly) goods, while incentivizing entrepreneurs and producers to find more efficient ways to produce sought-after goods or to find desirable alternatives. Price controls blunt such market adjustments, causing unnecessary shortages and surpluses and deterring innovation.
President Richard Nixons wage and price controls in the 1970s led to shortages and did little to stem inflation, which dogged both his immediate successor, Gerald Ford, and President Fords successor, Jimmy Carter. The same policy would not lead to a different outcome today.
Inflation ultimately is caused by too much money chasing too few goods and services. Its not hard to see how the United States got into this inflationary situation during the COVID-19 pandemic. On the money side, the federal government pumped more than $6 trillion into the economy, while the Federal Reserve accommodated with historically low interest rates, encouraging even more spending using borrowed money. Meanwhile, on the goods and services side, production was impeded by shutdown orders and other pandemic-related disruptions, both at home and in our supply chains abroad.
Stopping inflation requires slowing the monetary stimulus while growing economic output. The Fed has signaled tighter monetary policy for 2022 and it appears that President Joe Bidens $5 trillion Build Back Better spending bill is stuck in political gridlock. That should slow the growth of the money side of the equation and somewhat cool demand.
But what can policymakers do to boost production, which also would help chill inflation? The answer: back off from policies that discourage the production of needed goods and services.
For example, since supply chain problems are limiting both U.S. production and access to imported goods, Washington could repeal (or suspend by executive order) the long-outdated Merchant Marine Act of 1920, better known as the Jones Act. This protectionist act restricts foreign ships from making stops at multiple U.S. ports by requiring cargo ships going between U.S. ports to be made in America and owned and crewed by U.S. citizens. Eliminating these restrictions would help alleviate supply chain problems in the short run while lowering overall costs and enhancing productivity in the long run.
Government policies also have contributed significantly to large increases in energy and housing costs.
With a gallon of regular unleaded gasoline costing more than $3.30 nationally on December 7, according to AAA, and likely to go higher, President Biden could (and should) reverse the restrictions he placed on domestic oil and gas production soon after taking office.
As a colleague and I document in our book Housing America: Building Out of a Crisis, the government also bears significant responsibility for high housing costs. State and local zoning restrictions, building codes, permitting regulations and red tape all limit production and increase prices.
Inflation is not a natural phenomenon. It is largely created through human action or inaction.
Even if they dont know all of the details, the public realizes this. Now they want the politicians to undo the mess they created.