López Obrador’s flirtation with imposing price controls to curb inflation is a lousy occurrence that has proven its failure over and over again in history. Already the columnist Isaac Katz (El Economista, April 4, 2022) clearly exposed the drawbacks and consequences of it.
To illustrate how unsuccessful temporary price freezes are, it is worth recalling the experience of the United States in 1971-1973. In August 1971, Nixon presented an economic stabilization plan with three actions: suspending the convertibility of the dollar into gold, a 10% tariff on the country’s imports together with a selective reduction in taxes, and a price and salary freeze for three months, since inflation was growing at an unacceptable rate of 4.7% per year. That was Phase I of the controls, followed by Phase II consisting of a series of price regulations administered by a Commission, also in charge of authorizing salary adjustments to the unions. The Commission established criteria to define the size of large companies in order to bring them under direct control and exempt the “small ones”. This contributed to the view that large companies are to blame for inflation, which generated political support for the controls by the population.
At the beginning of 1972, inflation had dropped to 3.3% and the success of the controls was proclaimed. However, inflation was reduced not so much because of the effect of the controls, but because the economy had an enormous idle productive capacity, coming from a mini-recession in the early 1970s. Towards the end of 1972, the Federal Reserve, led by Arthur Burns, misread the artificial fall in inflation and the boom in economic activity, and initiated a very expansionary monetary policy. With monetary policy lagging, Burns thus planted the seed of the 1974-75 inflation.
In January 1973, Phase III of the controls was adopted, focusing caps on certain sectors (construction, health) and adopting “recommended” guidelines. Given the failure, because in addition the monetary expansion was already making its pressure felt on prices, Phase IV was imposed in August with characteristics similar to Phase II. Unlike Phases I and II, Phases III and IV took place in an economy with very tight markets causing serious disruption. It became clear that the effects of controls on profit margins ran counter to market forces and distorted business incentives. Despite the controls, the caps did not alter the long-run relationship between prices and unit labor costs, causing the profit margin to gravitate toward its market-determined level.
In 1974, faced with failure, this price policy was abandoned in the midst of the international oil shock, the imminent resignation of Nixon and the loss of prestige of Burns, who despite everything ended his term until 1978. Thus, one more lesson remained on how price controls do not work, worsening what they originally wanted to fix.
Twitter: @frubli
Economist
IMEF Magazine
Economist graduated from ITAM. He has a Master’s degree and doctoral studies in monetary theory and policy, and international finance and trade. Columnist for The Economist. He has been an advisor to the Board of Governors of Banxico, Director of Institutional Liaison, Director of External Relations and Coordinator of the Governor’s Office, Manager of External Relations, Manager of Macrofinancial Analysis, Deputy Manager of Macroeconomic Analysis, Deputy Manager of International Economy and Analyst .