By Dr. Mike Walden
Fifty years ago, I was sitting in a summer school class studying microeconomics. I had just switched my major from architecture to economics. In order to still graduate in four years, I had to take classes in the summer. I scheduled classes for the morning so I could continue my warehouse job in the afternoon.
On one particular warm morning in August, the instructor entered the classroom very excited. He said the economic and financial worlds had just been turned upside down.
Here’s what happened. In a nationwide speech the previous evening, President Nixon announced two momentous decisions. First, the U.S. gold window would be closed. Foreign countries could no longer convert dollars they held to gold owned by the U.S. Second, for ninety days there would be nationwide freeze on prices and wages.
I’ll save a discussion about closing the gold window for another time. Suffice it to say the gold window has never been reopened, and the trading of currencies is now done just like the trading of any commodity.
The price and wage controls were a reaction to a stubborn rise in inflation. In the previous five years the annual inflation rate had doubled – from three percent to almost six percent – and over the previous decade the yearly rate had jumped six-fold.
The price and wage controls implemented by the Nixon Administration were economy-wide. This is different from price controls that regularly are applied to particular industries where there is little or no competition. A good example is the power generation sector. Due to the large expense of building power generation facilities, one power firm usually serves a geographic area. Hence, there is no competition to keep prices in line. States therefore regulate power prices– such as electricity.
The intent of the Nixon plan was to “cool off” the economy and purge high inflationary expectations from decision-making. Initial polls indicated the country backed the price and wage controls. And while the measured inflation rate was moderated for a while, the success didn’t last, even after a second round of controls was instituted. Within a couple of years, the inflation rate was higher than ever. Ultimately it would reach double digits for three years in a row. It took a deep recession to bring the annual inflation rate back to the low single digits.
What happened? Why didn’t the price and wage controls of the 1970s work? The answer is the controls didn’t address the underlying causes of higher inflation.
Fundamentally, prices rise faster when spending on products and services is growing faster than the production of those products and services. In the 1960s and 1970s, spending rose rapidly due to two factors. There were large jumps in federal spending as a result of the Vietnam War and expanded social programs. Also, the Federal Reserve accommodated this spending by lowering interest rates, particularly in the late 1960s and early 1970s. The Nixon plan didn’t directly focus on these issues.
Apart from being ineffective, many economists think price and wage controls create problems for the economy. A big potential problem is shortages. In a competitive market, a price increase can be a signal that consumers want to buy more than is available. Producers act on that signal by making more and therefore satisfying consumers’ desires to have more of the product. If prices can’t rise, then consumers’ wants aren’t met and shortages of the product result.
There can also be challenges managing price controls. Millions of prices and wages must be monitored. Creative tactics can be used to avoid the controls. A famous example from the Nixon controls involved plywood. To get around the controls, an innovative company drilled holes in plywood boards. The company claimed the “holey plywood” was a new product and therefore not susceptible to the price controls.
Some economists see today’s economy as similar to the economy fifty years ago. Federal spending surged in 2020 and early 2021 from the numerous COVID-19 relief bills. Spending could rise even more if proposals to address socioeconomic issues like physical infrastructure, climate change, poverty and education are passed. The Federal Reserve has also kept interest rates at historically low levels and has supported federal spending by expanding the money supply at double-digit rates.
So, while I’ve not heard of any proposals for economy-wide price and wage controls, don’t be surprised if they emerge. During the last two months the annualized inflation rate has been running at five percent, well above the average rate this century. Although it’s not yet clear if new spending ideas will be implemented, some say it doesn’t matter because current spending may be enough to keep the pressure on prices. Also, there’s no sign the Federal Reserve will “cool” the economy by raising interest rates.
The conclusion is we may be headed for a new debate over price and wage controls. If higher inflation persists, and if the underlying causes aren’t addressed, at some point the public may clamor for the controls. Good idea? You decide. And PS: my microeconomics instructor gave us a pop quiz on price controls at the next class!
Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.