Stephen Monrad

If inflation spirals up when a market economy gets close to full employment, the only way to run an economy at full employment, I believe, is to control price increases somehow.

Now, most economists believe price controls are bad because they break the price mechanism that is supposed to bring supply and demand into alignment. For example, if rents are forced artificially low, the result isn’t just cheap housing, it is also not enough housing. Price caps create shortages.

This simple story is quite compelling. I am, however, quite determined to find a way to tame inflation so that the economy can run at full employment. Let’s look at why price controls cause shortages.

Returning to the rent control example, if rents are capped, two problems are created. First, apartment building owners find that they can earn more money by converting their buildings to condos, selling the units, and investing their money elsewhere. Second, the cost of building apartments cannot be recouped from the rents tenants are charged. The consequences of rent controls are that existing rental buildings are taken off the market and no new ones are built.

The problem with rent controls is that rents get out of alignment with other prices in the economy. If you want to control rents, you have to control other prices too. You need to control the price condos sell for and the costs of the things used to build apartments. If these prices are lowered, rent controls won’t cause the supply of apartments to go down.

Of course, if you control the price of condos and the things needed to build apartments, the price of all sorts of other things will need to be controlled as well to make sure their supply doesn’t dwindle either. If you want to control the price of one thing effectively, you probably need to control the price of everything in the economy.

Nobody has ever tried to control prices systematically across a whole economy without planning the whole economy in its entirety. If prices could be systematically controlled across the entire economy, perhaps inflation could be reigned in. The trick is to find a way to prevent inflation while still preserving local decision making about most production decisions.