wage and price controls – Warren's space

The good news is that the Presidential campaign has moved on to the presentation of policy positions—at least on Kamila Harris’s part–Trump’s response at a Pennsylvania campaign stop over the weekend was that “she’s gone “full communist.”

The bad news is that in addition to continuing some of Trump’s bad economic policies (tariffs, buy American protectionism, etc.) some of Harris’s economic policies are bad. Here I will take a closer look at her promise to ban “price gouging” by grocery stores.

In March of 2020 US. Broad Money (M2) growth jumped from its usual 5 to 6% per annum growth to over 25% a year later. As a result, U.S. Inflation (CPI) began to increase rapidly above its 2% target at the beginning of 2021. The Federal Reserve did not begin to tighten monetary policy until a year later when inflation had already reached 8% per annum. In addition, federal government deficit spending exploded over the same period. To fight this inflation the Fed’s policy interest rate was increased from almost zero from March 2022 to 5.3% by mid 2023 where it remains, thus ending M2 growth.

Since its disastrous late start in monetary tightening, the Fed’s management of the return of inflation to its 2% target has been as good as I could hope. Inflation has fallen below 3% without (yet) causing an economic slowdown. My guess is that the Fed is slightly behind the curve and should have started reducing it policy rate earlier this month.

So what is Harris’s ban on price gouging all about? “Perhaps Harris’s most surprising policy announcement was her plan to ban “price gouging” in grocery and food prices. While details were sparse, the measure would include authorizing the Federal Trade Commission to impose large fines on grocery stores that impose “excessive” price hikes on customers, her campaign said. Grocery prices remain a top concern for voters: Even though the rate of increase leveled off this year, grocery prices have jumped 26 percent since 2019, according to Elizabeth Pancotti, director of special initiatives at the Roosevelt Institute.” https://www.washingtonpost.com/business/2024/08/16/kamala-harris-2024-policy-child-tax-credit/

In an excellent editorial last Friday (I urge you to read it) the Washington Post asked: “‘Price gouging’ is not causing inflation. So why is the vice president promising to stamp it out?” https://www.washingtonpost.com/opinions/2024/08/16/harris-economy-plan-gimmicks/

Stores only offer goods for sale when they can be sold for more than their cost to the story by enough to pay for their own employees, cost of their store and its maintenance and “normal” profit (return on the investment made by the store’s owners). The erratic economic events of the last few years create disruptions in these normal relationships that can produce temporary losses and/or usually large profits.

The supply and demand for a good can be matched by its price or by some other form of rationing. If a pandemic suddenly spikes the demand for facemasks, it will take a while for manufacturers to increase the supply. Until that happens demand will exceed supply. Dr. Fauci and the government can ban sales to us common people in order to reserve the existing supply for doctors and nurses, or the market will increase the price such that only those with the most pressing need (or desire) will pay the higher price of the available supply. Rationing by prices has two big advantages. The first is that each individual (rather than government bureaucrats) determines whether their need is strong enough to pay the higher price. This makes it MUCH more likely that face masks will go to those with the highest need. Second it maximizes the market incentive to increase production and supply faster.

It the supply (relative to demand) shortage is not rationed by price, some other rationing mechanism and criteria must take its place. One is first come first served until the shelves are empty. During the wage and price freeze imposed by President Richard Nixon starting on Aug 15, 1971, gasoline was rationed by long lines of cars waiting for their turn at gas stations. It is not surprising that freely determined market prices have served us so well.

Supply and demand. Supply and demand.

Every economist of all political persuasions knows that the price of oil in a free market is determined by its supply and demand. The price of oil has risen a lot because its supply has been reduced by the Russian sanctions and the war in Ukraine and because with the easing of the covid pandemic restrictions demand has returned for people to travel on the road and by air. Before you decide what you think should be done about this, let’s be sure you understand how supply and demand works in this (and most every other) case.

The price of oil (let’s talk about gasoline) equates its supply with demand. Gas (short for gasoline in this note) refiners (and those who search for it and drill, pump it out of the ground and transport it to the refineries) and their retail gas stations that sell it to us, sell it for the highest price they can get away with. But if they set their price too high their customers will buy from a cheaper gas station around the corner and or reduce their driving or will double up for the commute to the office, etc. People cannot buy more than is available. Allowing the market to freely set the price means that those with a stronger demand get it and those with a more moderate need pass it up. The available supply goes to demanders whose demand is prioritized by those most willing to pay for it. Gas’s high price rations out those with weaker demand.

Suppliers will continue to explore and drill etc., as long as it is profitable to do so (i.e., as long as the pump price is higher than the cost of finding and refining it). Gas’s high price will encourage the production of more of it.

This helps us evaluate what to expect or what to propose in response to current high prices. The supply side is much more complicated by government regulations and OPEC monopoly agreements among producers, so let’s start with the demand side.

Those of you my age will remember the gas price caps imposed by tricky Dick Nixon in 1971 as part of his wage and price controls to fight inflation. It was a wonderful economics lesson for almost everyone. At the lower price of gas at the pump, demand exceed supply and therefore there was not enough for everyone to buy it who wanted it at that price (demand exceeded supply). Thus, long lines formed as people waited hours for their turn at the pump. Some cities alternated days in which people with license plates ending in an odd number or even number could enter the city, and other crazy things. If demand is not being rationed by price, government bureaucrats will decide who gets it; or the willingness to wait in line for hours will be added to the price as a rationing devise.

On the other side of the supply/demand equation, price caps reduce the incentives to find and produce more gas. Many factors influence the costs and thus profitability of increasing gas supplies. Environmental regulations, pipeline approvals or disapprovals, some well-considered and some less so, raise the cost of supplying gas. OPEC (Saudi Arabia, Russia, Venezuela, Iran) and geopolitical factors complicate the picture. For many years after Nixon’s wage and price controls most everyone understood that they were a very bad idea.

Hopefully we don’t have to learn that lesson again. The environmental and other regulations that increase the cost of supplying gas and thus reduce its supply need to be carefully considered and justified by honest cost benefit analysis.