Vinod B
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Vinod B

Price Controls Aren’t Always Terrible (Short Term) Policy Tools

They can reduce harm but the policy specifics matter

A central policy question today is how to deal with current inflation, which is at levels unseen since the 1970s-1980s.

Calculated from CPILFESL series from FRED

Traditional policy is for the Federal Reserve to tackle soaring inflation through raising interest rates that cool off the economy, reducing demand and lowering future price increases.

Recently though, the idea of price controls have seeped into the conversation with some calling for setting a ceiling on prices of certain goods to reduce inflation. Many of these commentators cite that price increases today are caused or exacerbated by corporate concentration, which gives firms monopoly power to charge higher prices.

This rhetoric is misguided because of the different timescales of the underlying issues. Corporate concentration has been going on for decades while high inflation is a recent phenomenon. Hence, corporate concentration can’t be the major underlying cause of recent inflation (though it can interact to make price rises worse than they otherwise might be).

Setting economy wide price controls can’t tackle the true cause of current inflation, whether it be excessive demand due the shift towards goods instead of in person services or supply chain issues, which are both caused by the pandemic.

Basic economic theory says that price controls lead to rationing and a disincentive for increasing supply in the long run, which is what would actually prevent higher prices, leading to lower inflation.

The basic idea follows from supply and demand dynamics:

Price Controls lead to lower prices yes but also lower supply and unmet demand

However, the key line in that economics 101 argument is the “long run”. How long is the long run? Is it 1 month, 5 years, or something else?

A big factor in determining how long the “long run” is, is how long it takes to increase supply, which in turn depends on the specific market we are talking about.

For example, setting price controls on things like meat or other basic food supplies is a bad idea because the production time scale is so short. Price controls would immediately affect the incentive to produce more. Supply can more or less immediately respond to price signals in good to fill gaps in the market. A better policy here is things like making the child tax credit expansion permanent.

However, for certain markets like the market for renting apartments, building new units takes a long time, meaning the lag between high prices and increased supply needed to eventually reduce that price pressure is quite long.

As a result inflation in rental prices tends to last longer due to this structural issue. Rising rental prices also impose a huge cost on existing, low income renters in expensive areas, leading to gentrification and the remaking of entire neighborhoods.

Obviously, the long term answer is not to enact price / rent controls, but they can be a reasonable short term policy to help protect disadvantaged individuals from being displaced and reducing transitory homelessness.

The key is to make these policies nuanced such that they don’t disincentivize long term building while still protecting existing residents. For example, the policy could enact rent controls in existing units only and be tied to a general measure of rent inflation, expiring once it drops. This would disincentivize improving existing units in the short run till supply increases and reduces the price pressure on existing residents while hopefully preserving the incentive to build new units.

The point is there are nuances for when and where price controls can be part of a reasonably managed set of policies due to the existing circumstances in a local market.

But in the long run, nothing will tackle inflation beyond increasing supply. Residents in expensive coastal cities need to allow zoning reform and tighter, taller buildings in their neighborhoods. Otherwise, the cost of living in these places will never drop because the market will always be in a state of excess demand.

In situations like this where short term supply is essentially fixed due to local constraints, temporary price controls aren’t a terrible way to reduce the economic costs for disadvantaged individuals, but they must be paired with supply side policies to boost production in the long run.

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Vinod Bakthavachalam

Vinod Bakthavachalam

I am interested in politics, economics, & policy. I work as a data scientist and am passionate about using technology to solve structural economic problems.