Ryan Bourne on *The War on Prices: How Popular Misconceptions about Inflation, Prices, and Value Create Bad Policy*

In an era plagued by high inflation and its pernicious economic effects, it’s more important than ever to dispel the many false notions surrounding prices and the crucial role they play in the broader economy.

Ryan Bourne is the R. Evan Scharf Chair for Public Understanding of Economic at the Cato Institute, and he is also the editor and contributor to a new book titled, *The War on Prices: How Popular Misconceptions about Inflation, Prices, and Value Create Bad Policy.* Ryan joins Macro Musings to talk about this new book, and specifically, the history and functionality of rent and price controls, the basics of dynamic pricing, the root causes of inflation, and a lot more.

Check out our new AI chatbot: the Macro Musebot!

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Ryan, welcome to the program.

Ryan Bourne: Great to be with you, David.

Beckworth: It's great to have you on and, full disclosure, I have a chapter in this book, so I know what to expect, but this is a great book, because it's a collection of essays from multiple authors. You, yourself, contributed as well and have a good sense of the overall volume. Maybe give us the background motivation for this book. Why did you want to put it together?

The Background Motivation for The War on Prices

Bourne: Evidently, as a result of the recent inflation that we've lived through that you talk about most weeks on your podcasts, we’ve seen a re-emergence of lots of terrible ideas about where inflation comes from, what we should do in terms of dealing with inflation, [and] the underlying causes of inflation. We've had the greedflation arguments, wage price spirals been talked about again in the UK, and as your chapter documents, this idea that all of the inflation so far has just been driven by supply shocks like the pandemic and the Ukraine war. I think, inevitably, when you get an unexpected inflation, it's in politicians' interest, [and] to a lesser extent central bankers’ interest, to deflect blame for any role that macroeconomic excessive stimulus has played towards malevolent actors in the economy or perhaps external factors. So, that explains the greedflation, the pandemic, the supply shocks, and everything else.

Bourne: In that environment, where people are misperceiving what has caused inflation, I think it lends people towards thinking about microeconomic solutions whether that's investing in ports, providing green energy subsidies through the Inflation Reduction Act, or at its most pernicious, price controls. Now, we haven't had people advocate for direct price controls, like Nixon style price controls, this time around, but in Congress, we have had people pushing for federal anti-price gouging laws. We've had people talking about banning shrinkflation. We've had Joe Biden's assault on junk fees. And I don't think it's a surprise that we've seen this occur in a high inflationary environment. So, I originally conceived of the book to address those misconceptions, but as I started getting into it, I realized that, actually, at a background level across the United States over the past decade or so, we'd actually seen a reemergence of a lot of other price controls in individual markets and sectors in a way that I hadn't really comprehended. So, we've seen rent control reemerge in many states and localities, not least California.

Bourne: We've seen aggressive increases in minimum wages. We've seen anti-price gouging laws emerge across, I think, 37 states. Now, we've seen caps on interest rates for short-term loans, we've seen credit card late fee controls, and what Joe Biden is trying to do with the junk fee stuff. And so, you put it all together, and I think there's this assault on market prices and the role that market prices play in the economy based on a lot of public misconceptions that are feeding through into politics. So, I wanted a book that was a full-frontal response to all of those different things going on, and that's what we’ve tried to achieve.

Beckworth: No, it's a great book. Again, the title is, War on Prices. So, it's a war on prices, and we'll come back to this in a minute, but prices are essential. They’re key to a well-functioning market system, and as anyone who's been following history knows, the world is moving more and more in direction of markets, although focusing on the past couple of years, you might push back against that claim, but, generally, the trend has been more globalization, more markets, and if we're going to go down that path, we have to allow prices [to] play their important role.

Beckworth: But just to go back to the motivation about the inflation surge— and we'll come back to the macro side of this book later in the show— but just up front here, just to note, I, too, was really surprised, not just by the inflation— I wasn't expecting it initially, but, in retrospect, I should have been expecting it— but just the salience of inflation, how much people care about inflation. Something I think most of us forgot— I think you saw on Twitter or X, as we now call it— today, preparing for the show, I was going back and looking at some polling data, and there's this Ipsos poll, and they poll across 29 countries, 20,000 plus respondents.

Beckworth: They asked, what's the top concern? And it's still inflation across the globe. Now, in the US, It's not the top one according to Gallup. It's still important, but across the globe, it's still the number one issue, and yes, it's come down, but it's very salient, and we saw in the election in 2022, it was a big deal, inflation, and to go back to the 1970s— late 70s [and] early 80s— you saw the Gallup polls, [and] inflation was a very important issue as well. And so, it was really, I guess, striking [and] educational for me to see that, to be reminded that that is the case. 

Beckworth: And one other observation before we jump into your book, something else I shared today on X, was that, at least in the US, households didn't seem to care much about inflation until it hit some kind of threshold level, and according to a Google search, 3.5% to 4%, somewhere in there, suddenly, people really begin to care. The inflation numbers track the search numbers, and [there’s] this threshold effect. So, people can go by year after year not thinking much about the price level or inflation. They think in terms of relative prices, but suddenly, when it goes above some level, it becomes a big deal for them.

Beckworth: So, I think, if nothing else, this should be a salient and an important book for politicians and central bankers to take a look at. One last thing on this as well, this also speaks to me the importance of the Fed not tinkering with the 2% inflation target too, right? If people really care about inflation— if they try to raise it, it seems that one thing we've learned is that people really care about Inflation. Okay, let's switch gears, though, and let's go back down, as you said, to this whole approach— not just macro, but micro— and let's talk about prices. Let's start from the very ground up, very basic, what is a price? What is your definition of a price?

The Definition and Importance of Prices

Bourne: Well, if you look at a dictionary, of course, it will say something like, a price is an amount charged for— usually in money terms— for a good or service being provided by somebody, but that's not really what we're getting at here. What we're getting at is the idea of a market price, which is the bottom-up reflection of all of the supply and demand forces, the market power forces, operating within a sector at any given time. And, as you say, prices are vital for coordinating economic activity. They're crucial because they contain Information that would be impossible for any one person to collect. So, you think about the cost of a loaf of bread. That reflects the cost of producing the actual loaf of bread, but it also reflects the effects of a harvest, perhaps, the effect of the war in Ukraine, any regulatory stuff that has been imposed on the suppliers of bread, meeting any FDA regulations. On the demand side, it reflects general attitudes towards eating carbs. It reflects people's income levels.

Bourne: It reflects so many different pieces of disparate information that no one individual would be able to collate, and the beauty of a market price, really, is that that information is all embedded within the price, and from that price and its movements, we are then incentivized to engage in certain behaviors. So, rather than talking in abstract terms, let's talk about a specific example. A couple of years ago, there was a baby formula crisis. I don't know if you remember that one. There was a factory that was closed down as a result, I think, of contamination or [of] breaching some regulation.

Bourne: As a result, it was quite an insulated market in the US. There was a baby formula shortage. All of a sudden, shelves were out of baby formula. Well, when that type of thing occurs, I, as an individual consumer, when we have free floating prices, don't need to know about what's going on in a particular factory in terms of contamination. I just walk to the store, I see that the price of baby formula is higher than it has been before, and I think to myself, maybe this is not the best time to stock up on three months worth of baby formula.

Bourne: Maybe I'll just get what I need for now, and, hopefully, this price will go back down to something closer to normal in the future. In doing so, I help alleviate the shortage somewhat by allowing more of the baby formula to remain on the shelves to people who value it and really need it more highly than I do at that time. At the same time, that price going up, of course, signals to other providers of baby formula— suppliers of baby formula who haven't been affected by this contamination— [that] now might be a good time to actually start supplying more of this stuff to the market, because the fact that the price has gone up sharply appears to show that, at the old price, there was a shortage of this good.

Bourne: So, they incentivized and have compensated for the cost of running overtime, for the cost of paying for extra drivers to transport their product, all of the little additional costs that they will incur as a result of ramping up production. So, even though that would lead to less being sold and a higher price overall, the effect of that supply shock in that individual sector— the movement of the price helps alleviate the shortage and gets us towards a more efficient allocation of resources. So, prices play a crucial role, not just in reflecting information, but incentivizing our behavior to use resources in the most efficient way.

Beckworth: Yes. Prices work so well when things are going according to plan. So, there's no interventions, no big shocks, but prices tend to work so well that we take them for granted, and part of the challenge is that they do work so well. It's a modern marvel. I think there's a TV show called Modern Marvels, and the price system is a modern marvel. And unless you take time to sit down and think through all of the linkages and the role it plays, it's easy just to think, "Oh, no big deal." You gave the example of baby formula, but I think gasoline is an example that I like to think through, so I'll throw that one out there.

Beckworth: If there's a war in the Middle East, oil supply shrinks, gas prices go up. I go to fill up my car for the weekend road trip I was going to do, and I see, "Oh my goodness, it's now $4 a gallon. Maybe I don't need to go on that road trip. I'll just stay home this weekend.” So, I have rationed— because of the price, I'm rationing and being more thoughtful. The flip side is, a few years back, when everyone was buying big trucks, and the demand for fuel was going up, it sends a signal to producers to make more. So, it’s amazing how this process works. Now, Ryan, I believe you like to invoke Alex Tabarrok. He has a little saying about this, [and it] kind of summarizes it very nicely. What is that?

Bourne: Alex's line is that a price is a signal wrapped in an incentive, which gets to the dual role of prices that I just implied. Yes, there's a signal behind prices about what the relative scarcity of the product is looking like at the moment, but there's also an incentive embedded within it to affect our behavior, which is what we just talked about. Perhaps another way of putting it, though, which I've used recently as well, is that prices, to a certain extent, are messengers. They're messengers about the reality of the world, or the changing reality of the world, when they go up or down. 

Bourne: And in effect, what we do when we advocate for government to control prices is, we get the government to hold a gun to the messenger's head and tell us a comforting lie about the reality of our situation, to imply that there's more product available than there actually is at any given time, if we're talking about a negative supply shock or whatever. Yes, they're really crucial for coordinating economic activity, and the conclusion of the book, looking through these historic case studies of where we've used price controls in various sectors, is that we mess with them at our peril.

Beckworth: I can't remember if it was Gorbachev or some other USSR leader who came to the US, looked in a grocery store, and saw that the shelves were full of food and was just marveled. “How is this possible? We find it hard in the Soviet Union to keep things in stock,” and it has to do with prices. Now, one more story that I would like for you to share with our listeners, and some may have heard this, but there's a fantastic little parable, and it's now a nice animated video called “I, Pencil.” Maybe tell us that little parable and why it really illustrates the beauty of prices in coordinating literally thousands of different people to create one simple thing, a pencil.

The Parable of “I, Pencil”

Bourne: Yes, I believe the original essay was written by Leonard Read, but then this was popularized by Milton Friedman, I think, in his Free to Choose program. He tracked the life cycle of a pencil and talked about all of the inputs that went into producing a pencil, and [he] made the observation that no one individual could make a pencil if they wanted to, because you need so many different inputs to it. You need timber, you need wood, you need lead to be mined, you need rubber from rubber plants. There's a whole range of different things.

Bourne: You need the metal casing to hold the rubber on the end of a pencil. So, even a simple pencil entails huge amounts of coordination and, actually, inputs coming from around the world. The supply chain for even something like a pencil is incredibly complicated, and Friedman was making the economic point that the beauty of a market economy, the invisible hand effect, is that the price mechanism enables all of these disparate individuals to cooperate without having to know each other, without having to know the plan for how to make a pencil. And each input provider meets the buyer in a market, and through that process, we get to the point where this pencil is made incredibly efficiently, and, as you say, it's something that we take for granted.

Bourne: We go to Target or CVS or whatever, and there are tons of these things just sitting there in the store, and we don't think about all of the coordination that has had to occur for that to get there, not just in terms of producing those inputs and outputs, but think of all of the associated downstream markets that serve the individuals, the companies that produce each stage of that process, the people who sell lunch to the people mining the lead or whatever. There's so much coordination that goes through all of this process, and it's a fantastic essay. I'd urge people to go and watch it, and I believe the Competitive Enterprise Institute actually did a five-minute video version, which is really fantastic. You can just find it on YouTube, and it's a must-watch.

Beckworth: Yes, we'll put it in the show notes, but it is amazing, as you said, all of the downstream-related inputs that come into it. So, I like to think of the guy who operates the chainsaw, right? He's cutting down the tree to make the wood. Oil has to go into that chainsaw. Someone had to make that chainsaw. Someone had to transport it. Someone had to feed him, as you mentioned, and then, of course, all of the people doing those things also had to be serviced at some point. So, that chain of individuals and services is truly long and deep and wide and global. One other story, just to illustrate, again, the power, the beauty, [and] the wonder of the price system and markets is a story about a fellow British citizen. I don’t know if he’s a friend of yours, but someone you may have heard about.

Bourne: We all know each other, David.

Beckworth: Yes. Thomas Thwaites. Have you heard of him? He was a British design student who attempted to make a toaster completely from scratch, and he did the mining and processing. He wanted to do everything himself, and this was back in 2009. So, he took on this ambitious project, and he had to literally obtain raw materials like iron ore, plastic, mica, nickel, and he ended up spending $1,800, took several months, and the whole point was to make this toaster. And it was really, really hard because, like you said, no one person knows everything that goes into that toaster. I forget who portrayed this, but it was on a documentary. Someone showed this process, and it's just really eye-opening. And, again, all of that is a whole lot easier when you let the market connect people doing different tasks.

Bourne: And the price mechanism is the essential glue there. There's another great example, actually, that I wrote about in my Economics in One Virus book, which is that there was a guy who, a few years ago, tried to make a chicken sandwich from scratch. He tried to rear his own chickens. He went to the sea to extract sea salt from the sea. He grew wheat and separated the wheat from the chaff. I think it was about $1,500 to $2,000 to produce this one chicken sandwich. And there's a video of him, and as he takes the first bite, somebody says, “How does it taste?” You can tell that he's extremely disappointed in the taste of this chicken sandwich.

Beckworth: So rich. Well, let's talk about the process there implied behind that, and I want to maybe step back, because we're stressing the price mechanism, and, really, what we're talking about, at least from maybe a generic economics perspective, is how do you ration among different objectives, different needs, and we're using the price mechanism. And as you point out in the book and elsewhere, there's other ways to do it. You can ration, or you can make adjustments— as an economist would say, on the margin— with prices.

Beckworth: You could also do it with quality or with quantity. And some of the examples that you bring up in the book were rationing on quantity, on quality. And just to make this a real simple illustration— and then we'll go deeper into some, maybe, less pleasant examples. But like when I go to the grocery store, the grocery store is rationing what I can buy based on price. I've got to pay a price. I want to get that box of cereal. I want to get that dessert, that vegetable. But at some point, maybe, they might run out of food, right? So, my Blue Bell cookies and cream ice cream, it runs out because everyone wants it.

Beckworth: Then, it begins to be rationed on quantity, first come, first served. You could also ration on quality, and one of the great examples of rationing on quality— in fact, these other two margins tend to kick in when you don't allow the first one, price, to do the adjusting, right? But I do think that it's fair for all of us to step back and say, "Look, there are always going to be three margins that you could choose from, or maybe a combination of them, to ration resources in the economy. Price is probably the best one. It is the best one, but these other two can kick in. And the example, I think, that's very useful in illustrating quality would be rent control. So, maybe talk to us about rent control, and if you start to use rent control— which, in other words, you can't ration on price, you begin to ration on these other margins, quality or quantity.

Rationing on Quality or Quantity: Rent Control

Bourne: Yes, you're completely right. So, with any price control held below the market rate, particularly for a prolonged period of time, you get these adjustments. Some people tend to think that when you think about holding the price below the market rate that you get this disconnect between quantity demanded, quantity supplied, [and] that leads to shortage. That can be true when price controls bind, but, in reality, a lot of price controls are imposed in markets where they're not universal. So, the price control might be applied to one part of the market but not, say, buildings built after 1995 for whatever, if we're talking about rent control.

Bourne: And so, one way for individual landlords to adjust to a below market regulated price, or not being able to increase their rent by the market rate, is, essentially, to allow the quality of their apartment to deteriorate to reflect the price that they are now able to charge. So, that might manifest itself, in concrete terms, through an unwillingness to invest in maintenance. You were thinking of replacing that bathroom, for example, to try and attract a tenant who was willing to pay more. Well, if your rent is going to be regulated, maybe that's not worth it as much anymore.

Bourne: Somebody, the tenant, has been complaining that the washing machine is taking too long, or doesn't wash the clothes properly. Is that something that you want to replace right now? Well, if your rent is being held down lower than the market would imply, then that might not be something that you want to do at the moment. So, there's actually really good evidence on this where, in states and localities where rent control has been in place for a long time, like New York, the quality— as measured by a bunch of as objective metrics as you can get in terms of the quality of the plumbing, heating systems, AC, yadda, yadda, yadda— the quality seems to be lower in places where you have rent control over long periods of time than in other places where you don't.

Bourne: One factor that can contribute to this is that rent control, also— because people are getting a below market rental apartment, people tend to stay in rent-controlled properties for longer as a result of that. There's a disincentive to actually leave them, because you lose the monetary benefit of that below market rate property, and as a result of that, people living in rental accommodation for long periods of time— and not owning it as occupiers who are willing to invest in maintenance— you can see a decline in maintenance that, coupled with the effect that I've just talked about, leads to a real deterioration in the quality of the property in the long run.

Beckworth: So, the key point is that there's going to be rationing on some front, on some margin, right? If there's a scarce amount of resources— unlimited wants and desires— one way or the other, tough choices will be made. So, we can pretend that we're being nice and benevolent, we're not going to use that evil price mechanism, we're going to set price controls, but, then, we end up doing the same thing, just through another mechanism. I guess that's the point that I would really like to stress here is that, one way or the other, there is going to be some form of rationing, and which one do you think is the most efficient, the most fair, the most equitable?

Beckworth: Maybe one other way to illustrate this would be like healthcare, and this is going way outside my lane, but some countries, they don't ration as much on price. In the US, it's mixed, and your book has a chapter on this. It's mixed, but there is more of a price element to the rationing in health care in the US. You go somewhere else overseas, [and] maybe they ration by quantity or by quality. The doctor has to see everybody, but then he doesn't do a very good job with everybody. Any thoughts on that?

Bourne: Yes, and I'll give a personal example of this. I once needed to see a dermatologist in the National Health Service in the UK. There's a single-payer healthcare system, free at the point of use, and I called up and asked them how long it would take until I could get an appointment, and they said, well, probably be three to four months. I then said, “Is there any way that I could be seen sooner? I really need this dealt with within that time period.” And they said to me, "Well, the doctor also does private appointments, and he could see you at 9:30 tomorrow morning for £200.” So, that's a good direct example of the rationing by price against the rationing by queuing, because, as you say, there's lots of countries in the world which operate single-payer health care, where they're willing to tolerate longer queues, longer wait times, because they think that there's some inherent value in everybody being on a level playing field in terms of access to healthcare.

Beckworth: So, tying this into the recent inflation surge that we went through, there were calls by some individuals for price controls as a way to deal with the inflation. Now, fortunately, we didn't see much of it. Was there much, or any, use of price controls? I don't recall there being any, but were there any applications of it?

Bourne: So, there definitely were, internationally. So, in the UK, home use energy prices were capped. There was a price cap and subsidy system. In many European countries, there were food price controls as well. In France, they had what's known as voluntary restraint, where the government has meetings with supermarkets and tells them, “You should keep the prices of these goods low, or else,” and that can often be enough to act as effective price controls.

Bourne: But, no, we didn't have a full-blown advocacy for price controls in the kind of World War II, Nixon, Korean War style, but there were a lot of economists, even here, who were— and commentators here who were pushing various forms of price controls. So, Isabella Weber— who has become one of the most prominent proponents of the greedflation thesis— she wanted what she described as selective price controls on housing and a couple of other goods, which she said were driving overall inflation.

Bourne: At a congressional level, we've had Elizabeth Warren who's been championing the Price Gouging Prevention Act, which would, in effect, have led to effective price caps on tons of goods and services during the pandemic, because that kicks in when there's emergencies. And, of course, Joe Biden has used people's discontent with rising prices as justification for his anti-junk fees agenda, which entails lots of smaller price controls, or, at least, controls on firms’ pricing structures. 

Bourne: So, even though even though we haven't had direct and extensive price controls, one of the reasons for writing this book is, really, to make the argument that this intellectual environment lends itself to this type of thinking. I've just been reading Carola Binder’s new book on the history of inflation and price controls in the US, and it's really telling, actually, that in periods where you do see price volatility, all of these policy ideas start re-emerging, and when you look at the polling, there's a worrying number of people— indeed, the modal explanation now for why we've seen inflation over the past four years— if you ask the public who is to blame— the overall modal bogeyman, right now, is corporations. So, I worry that this thinking will lead to bad policy next time an inflation emerges, so, we need to head off these arguments right now.

Beckworth: You have a chapter in the book from a contributor named Eamonn Butler, and he has a book with a co-author, and the book's title— he references this in his article— but the book's title is, 40 Centuries of Wage and Price Controls, so a very long history. And he has this really great line in the book. On page 97, he says, “no economic policy has been tested so long, so often, among so many peoples, and in so many places, nor does any have such a uniform record of failure.” So, I loved this. It’s very succinct and on point, and in the book, you too have some discussion of these price controls. I want to go there with the World War II examples. So, you mentioned some of these individuals, they invoked World War II. "Hey, it worked out then. Yes they don't always work out, but man, World War II, they sort of worked,” and you have a chapter saying, actually, they didn't work out that well, so maybe talk about that experience and what we’ve learned from it?

The World War II Experience with Price Controls

Bourne: Well, people are much more willing to tolerate price controls during wartime, because, effectively, you're suspending much of a market economy. The aim isn't economic efficiency and growth anymore, the aim is to defeat Hitler, and so, as a result of that, the state is directing tons of resources to that end. So, prices tend to not give us as much information as they otherwise would, and, perhaps, because you want everybody to have access to certain essential goods at affordable prices, the state is stepping in and capping prices and then imposing rationing, which is what you have to do if you can't really ration by price.

Bourne: You can make that argument, and that argument is much stronger in mass mobilization wartime than any other time, but Isabella Weber and a couple of others went further than that and said, "Well, actually, World War II price controls were a success, because during the period when they were imposed, prices rose less quickly than after they were removed, and during that time period, the poorest seem to do okay, and they had greater access to meat, and their living standards seemed to be fine, so, therefore, it was all good.”

Bourne: “Why don't we try something like this again, just impose selective controls this time around?" And I think that's a huge misreading of the situation, so, of course, it is true that if you ban companies across the board, and there were extensive— we're talking extensive price controls here, almost all goods and services not being able to increase prices. If you do that, of course, it's a bit like if you were to set a cap— I think Don Boudreaux told me this— it's a bit like if you set a weight cap on a scale, a maximum weight cap, and then you stand on the scale, and your weight stops at that thing.

Bourne: That doesn't mean that the control that you've imposed on the scale is causing you to lose weight. It just means that you're not measuring inflationary forces that are underlying that balance between the amount of money in circulation being spent and the amount of production. You're not picking that up. So, what's going on? Well, Milton Friedman and a few others really did some good work on this, where they showed that because prices weren't able to adjust, there were lots of other margins of adjustment, the sorts of things that you were mentioning, that meant that the welfare effects of price controls were much more harmful than Isabel Weber implied.

Bourne: There were extensive black markets, really extensive black markets, to the extent that the Office for Price Administration at the time, the head, talked of such extensive conniving that he actually questioned the strength of the moral fiber of Americans. The quality of goods— there were huge declines in the quality of goods. People complained about meat that you just couldn't cut, sausages and hot dogs full of beans and potatoes, dry grass being sold as tea, extensive shrinkflation.

Bourne: We hear a lot about shrinkflation now, extensive shrinkflation. And so, once you account for these quality effects, then, the fact that certain goods just weren't available at all— there's stories of journalists having to go to seven different stores to find a soda. And then, you take into consideration the black market and all of the illegal activity. Actually, what was really going on is that a lot of the underlying inflation was just being suppressed by price controls, and inflation wasn't being ameliorated to a first approximation. So, it’s a hugely Panglossian look at the impact of price controls.

Bourne: And for all the talk about the poor doing better when price controls were in place, people have looked at people's consumption patterns rather than income patterns, which tend to be distorted during wartime because, what is the value of things being produced when they're being dictated by the state? When people look at consumption patterns of consumers, they improved dramatically after price controls were removed. So, I really wanted to push back on this idea that, even in wartime situations, like wartime, where we might be willing to tolerate these types of impositions, that they lead to good economic effects.

Beckworth: There's a story from that period about a loaf of bread. The price was regulated, and as the cost of making that bread went above the price they could sell it for, bakers and other companies that made bread, they started putting cheaper ingredients into the bread in order to make it worthwhile to make bread at all. Then, people began to complain. So, maybe it was this Office of Price Administration, OPA, it was them or some other government agency that started issuing regulations. “This is what a loaf of bread is,” and they listed all of the ingredients. Then, the bakers say, "Okay, we'll add ingredients that they haven't outlawed yet.” 

Beckworth: It was this cat and mouse game between lowering the quality of the bread [and] trying to stay ahead of the regulations. By the end of the war, there was actually a book on, what is a loaf of bread and how do you make it? That is, to me, a waste of resources where you spend time trying to define what is a loaf of bread. And you give examples in your book that happened, like you said, meatpacking, other places, the time costs. So, you're not really solving the problem, and, again, this is the point that I really want to stress from this book. Price controls don't really change the fundamental problem. The impression is, "Oh, we impose a price control, and it takes care of a problem,” but it doesn't. It just pushes it into another, again, margin, another way of rationing, another form of rationing, quality or quantity.

Bourne: Yes, I can't remember if it was World War I or World War II, but there was another instance where there were caps. I think it was World War II. There was a cap on the price of wheat, and as a result of that cap on the price of wheat, it became cheaper for farmers to feed the wheat to some of their— I can't remember if it was cattle or whatever. This was at a time where there were shortages of bread, where people really wanted bread. So, you get these effects, and as you say, if you want to enforce price controls as well— By the end of World War II, and bear in mind, much smaller population then, there were 64,500 staff at the Office for Price Administration, and it was reliant, at the same time, on 108,000 volunteers. So, a really extensive regulatory apparatus, not to mention the people within companies that were having to work to comply with the regulations and talk to the regulators. So, apart from nothing else, with my libertarian hat on, these are big impositions on people's liberty, and they come with big administrative costs as well.

Beckworth: Okay, one other historical period of price controls you've mentioned already, but, maybe, let's spend a few more minutes on Richard Nixon's price and wage controls. What happened there?

Price and Wage Controls During the Nixon Administration

Bourne: We didn't we didn't explore those in as much detail in the book, but we do have a really good chapter by Peter Van Doren that looks specifically at the oil and gas price controls, because that's what people tend to remember. They tend to remember the gas lines, and the big takeaway that I would—And, definitely, there were periods of shortages. So, there were shortages of heating oil in '72-'73, '73-74 winter, and in 1979, again, for gasoline. That's the image that people really remember.

Bourne: But the big takeaway that I took from his chapter, actually, was that these types of price controls often lead to extensive political corruption almost, and extensive calls for opt outs and carve outs, overall, for oil for most of that period. And these were in position for most of, almost all of the 1970s. For most of that period, it was about 60% to 70% of oil that was under some form of price control, on average, holding between three and five dollars per barrel below market levels.

Bourne: But for most of that period, the price controls were kind of incomplete. So, that means that you were seeing that they didn't bind totally. So, we didn't just see shortages. What was really going on was that the consequence of the price control is that we were seeing these huge transfers from domestic crude oil producers to refiners. That led to extensive political lobbying for opt outs and carve outs, and you had different price controls on new oil, because they didn't want to deter new oil production. Then, there were different price controls on imported oil.

Bourne: And so, you saw these big transfers, which ultimately created a big deadweight loss to the economy. So, the big takeaway that I took from that is, in situations where you have price controls, even if they don't manifest themselves in those direct shortages that we often think about when you hold market prices below market rates, they can lead to extensive political lobbying, favoritism, and huge redistribution between different industries.

Beckworth: So, you have a chapter on minimum wage. I don't want to spend too much time there, but if you've been following the debate online or even in the literature, it tends to focus on employment effects or hours worked, right? And I don't know if it's a consensus, but there's a lot of work done that says, "Well, the minimum wage laws really don't have that big of an employment effect. The magnitudes are really, really small." But you have a chapter in your book, I believe, by Jeffrey Clemens. Is that right?

Bourne: Yes, Jeff Clemens.

Beckworth: Jeff Clemens. And he goes and does exactly what we've been talking about. He says that even if that's true— and you can contest those findings— but even if that claim is true, that the margin, in terms of employment or hours worked, even if that doesn't change, there are other margins. There's still some kind of rationing taking place. So, walk us through that.

The Effects of a Minimum Wage

Bourne: Yes, so this is an emerging area of the literature. So, I'm really excited that Jeff was able to write this chapter, because he's the preeminent thinker in this area. So, as you say, there are lots of other margins of adjustment that businesses can make to try to recoup any financial hit that they're taking from a minimum wage increase by adjusting other aspects of their costs. So, Jeff walks us through theoretically and some of the evidence, other ways that firms can adjust. One way that firms can adjust to a higher wage floor is by reducing non-wage benefits.

Bourne: There's quite an extensive literature now that when you have a higher minimum wage rate, employers are less likely to provide health insurance. There's less information about the quality of the coverage, but, certainly, in terms of access to health insurance and other employee discounts or benefits, there's a growing evidence base that those are affected adversely. A higher minimum wage tends to lead to reduced amenities, whether that's less investment in the physical workspace, less training provision, tighter performance review, [or] less individual worker control over their schedule, their work schedule.

Bourne: So, firms are really looking to find ways that they can make sure that workers are as productive as possible, and sometimes that leads to quite extensive sweating of employees harder and tracking their productivity more closely, and a lot of other things that make, in effect, the quality of the job— the amenity benefits of the job— lower than they otherwise would be. So, you can have a situation where a worker, on paper, benefits financially from a higher minimum wage, but it may well be that their job is now significantly more unpleasant because of the adjustments on these other margins. Now, even aside from all of that, just looking at the crude number of jobs or hours can be misleading as well, because one big margin of adjustment is that employers can adjust the type of employees that they hire.

Bourne: And now, I think there's a pretty good basis of evidence across a range of different papers that when the minimum wages increase significantly, firms are more likely to hire people who have established track records within the industry [and] are regarded as higher-skilled workers, or at least more experienced workers. And so, there can be redistribution effects in the opportunities for entry-level employees, new employees who don't have much of a track record in an industry. They find it much more difficult to get work relative to people who have, perhaps, been doing the job for a good number of years.

Beckworth: Alright, one more chapter on micro, and then we'll move to macro, and that's the chapter on dynamic pricing. What is dynamic pricing, and is that actually something that we should be optimistic about? Because maybe with AI, with big data, we can get a world of truly market-driven prices based on demand and supply.

The Basics of Dynamic Pricing

Bourne: Yes, so dynamic pricing is, essentially— we're talking about algorithmic-based pricing that most of us have experienced when we use Uber surge pricing. When there's a big spike in demand for cars, Uber's prices go up to reflect that extra demand. And this is actually being rolled out in more and more industries. So, across the entertainment sectors, you're seeing dynamic pricing on ticket sales, on Ticketmaster. Some bars have gone beyond just having happy hour now and are adjusting their prices more depending on how many people are actually in their establishments.

Bourne: Of course, famously, a couple of months ago, Wendy's, on an earnings call, implied that they might be installing new pricing boards, which would enable them to adjust prices to reflect demand conditions. They say that they weren't actually doing it for that reason, that it was more for promotions, but that's how it was perceived. And to a certain extent, this does mean that prices will better reflect demand and supply conditions. I don't think, as people who consider themselves market-sympathetic economists, that we should tell businesses what to do and imply that this is always good for consumers, to introduce this.

Bourne: Clearly, if you're in a situation where you're going for your lunch and every day you go in and the price has changed, there's a search cost for you to find a bundle of price and quality that you're happy with. So, there are good reasons why, in certain industries, consumers might not want this. But certainly, as an experiment and as a form of pricing innovation, this is something that I think we're going to be seeing more of, and if consumers like it, I think that it'll be rolled out to more and more industries. Now, what are the benefits? The major benefit is that you end up rationing more by price rather than some of those other mechanisms that we spoke about earlier.

Bourne: So, at the moment, if I go into a grocery store, for example, at 6:00 PM here in DC, I'll probably wait 20 minutes in the line to pay. It may well be the fact that certain things that I would really like are unavailable anymore in the fresh bakery section, for example. And it may also be that certain goods that are, perhaps, not as in high demand as the supermarkets are expecting are just thrown away with waste. They're due to go off because they've passed their sell-by dates, use-by dates. So, an advantage of dynamic pricing in this area is that you can mitigate that waste. You can reduce that waste by having the price fall as you get closer to the use-by date.

Bourne: You could be in a situation where you could ameliorate some of those queues by varying prices through the day, such that you encourage more people to come at off-peak times. And so, for certain consumers, particularly low-income consumers who are, perhaps, more sensitive to price— much in the same way that we've seen the unbundling of airline fees and charges that has enabled lower base fares— you may well get to a situation where lots of goods and services that people really want are available more cheaply for low-income people than, perhaps, they are right now. So, the basic economics is the same as the things that we've been discussing. I'm not saying that this is what businesses should be doing in every industry, but there can be clear benefits for consumers, particularly in markets where you want a continuity of supply, and particularly in markets where people have a very different willingness to pay, depending on when they're purchasing the good or service.

Beckworth: Now, this is just price discrimination, and I listened to you on another podcast, which will remain unnamed, and the host, who's very free-markety, was uncomfortable with this. I'm like, "Bring it on." This is like living the dream here in terms of markets and prices.

Bourne: He was talking about a world in which everybody's willingness to pay was effectively tracked through their activity over time, so you had completely personalized pricing. Of course, this is just a different form of what we've been talking about. It's just the expansion of it to full price discrimination.

Beckworth: Right, right. You can ask one of us later if you want to know who this host and podcast was. Okay, let's move to macroeconomics, and that's where I did my chapter, and you had a chapter, and several other people did contributions. I'll just summarize one of the big points we made, [which] was not all of the inflation during the inflation surge was due to supply shocks. Yes, there was some meaningful amount of it due to that. The pandemic, the Russia-Ukraine war, those things definitely made a difference, but we have to also acknowledge the fact that fiscal policy, monetary policy played a big and important role as well. When the federal government expands the debt stock by $5 trillion, and I think you stressed the amount of the big increase in the stock of money, things are going to happen, especially if they're perceived to be permanent. They're not going to be reversed at some point going forward.

Beckworth: What I want to do with this part of the program is jump into a definition of inflation that I know you like to use. I've heard you use it, and I think it's in the book as well. You like to invoke Milton Friedman, where he says, "Inflation is too much money chasing too few goods." So, I'm going to ask you this first, and then I'll tell you my answer, but what part of that definition do you think is the most important part? Is it the too much money, is it the chasing, or is it the too few goods part? Where would you come down as the most important part of that definition?

Defining Inflation and Establishing its Sources

Bourne: I think it depends on what time period you're talking about. In the very, very short term, I think that you can have periods where, as we did, we lived through, we had supply shocks that affected the propensity to produce goods and services in the economy. As a result of that, if you have the same amount of money chasing fewer goods and services, you can get a spike in the price level that obviously represents itself in the inflation measure as a sharp increase in inflation, but a very transitory one. So, I think what we've known since the 1980s and Robert Lucas's work is that, I think, most of us agree in the longer term, [that] money is more neutral. So, money doesn't tend to have too big of an impact on real output. And so, when we're thinking over the longer term, I think that Milton Friedman is still essentially right that the big driver of inflation is the amount of broad money in circulation, but you're much more of a macroeconomist than I am, David. So, I'm really interested in your alternative take.

Beckworth: That's a very nice and careful answer, short term, long term. I was just going to go with the chasing part. To me, that's what's key, because you could, in theory, do a helicopter drop, lots of money, increase checking accounts, money market accounts for households, and they choose to sit on it. The key is that they've got to chase, they've got to take the money. So, I guess what I'm trying to say is, it's not the money supply itself, it's the use of the money supply. I think that, to me, that's key, and that, in turn, is driven by expectations. Do you think that this money that was injected, is it truly a gift, an increase in your wealth? It's permanent from the household perspective, but it's an increase in wealth from the government's perspective.

Beckworth: It's a permanent increase in government debt or increase in the money supply, therefore it's going to be inflationary. I think, to me, that's the key. It's chasing. That's where the velocity comes in, and I want to use that as a segue. The book spends a lot of time on the role that the Federal Reserve played, central banks play. Where would you come down on central banks versus fiscal policy? Maybe we should limit this to the case of the US because the US was, I think, exceptional here. In 2020, President Trump, his administration had a role to play. President Biden, in 2021, [had] big fiscal packages at the same time the Federal Reserve was keeping rates low and buying up assets. Where would you come down on it? Was it the Fed or was it more fiscal and the Fed following fiscal?

Bourne: I tend to fall more down on the Fed. If you take the broad money stuff seriously— and I completely take into account what you're saying— the way that the money manifests itself is through the impact on total spending, right? We're not differing on that. The broad money supply— I know it's not a perfect measure and we can debate the measures— but the M2 money supply went up by $6 trillion, I think, between the start of 2020 and mid to late 2021, so, a huge expansion in the money supply. I definitely think that the American Rescue Plan— $1.9 trillion at a time when the economy was recovering.

Bourne: I don't know how you think this through as a matter of economics, but that, to me, was like throwing fuel on the fire at a time when households’ net worth had already spiked pretty significantly. And so, I think that could increase the velocity of money through the economy. I don't know if that's the way that you conceptualize it. So, I think that fiscal definitely had a role, but the way that I understand it is that that impact on velocity from fiscal policy tends to be more temporary. So, I don't think that you see the big permanent increase in the price level that we've seen without that monetary accommodation, which is why I ultimately come back and say that if you look across the period as a whole, the last four years— and yes, we had supply shocks at various times— but you look at the total change in the price level.

Bourne: I think that the PCE is about 8 to 9% above where it would have been if we'd have hit the 2% target throughout. Then, [if] you look at total spending across that period, I think it's 9% above where it would have been otherwise. It's very difficult to escape the conclusion that excessive macroeconomic stimulus has driven most of the inflation across the period as a whole, if we're thinking of the inflation as a four year period.

Bourne: Within that, I'm less certain as a non-macroeconomist as to how I break that down between monetary and fiscal authorities. But ultimately, the monetary authority is supposed to react in trying to meet its inflation target to what the fiscal authority is doing, and I think it was obvious by 2021 that the fiscal authorities were really intent on borrowing trillions and trillions of dollars. So, whatever way you approach it, I come back to imposing more blame on the Fed, I'm afraid. So, I'm sorry if you've got any people working for the Fed listening.

Beckworth: Well, I'm sure that we have people on both sides of this argument. I do think it's useful to use the equation of exchange, as you do in your chapter, and it's in the book, I think, elsewhere. I guess that I would just say that to get a permanent increase in the money supply— And I'm going to think very narrowly, like on the Fed's creation of money— [It] presupposes that the federal government will not, in the future, pull it back out. The Fed won't pull it back out. And because of the intertemporal government budget constraint, what it means is that the government's not going to raise taxes, it's not going to retire some of its debt in the future. So, for me, it's hard, I guess, to separate the two.

Beckworth: I would say this, though, whether you want to put blame on the Fed or on fiscal, I guess I would lean a little bit more on fiscal and the Fed accommodating fiscal. That's the way, I guess, or the story I would tell. The bottom line is this— and I know we both agree on this— is that the dollar size of the economy right now is about $2 trillion larger than it would have been had it stayed on the same trajectory in terms of growth, positive growth in the dollar size of the economy.

Beckworth: So, I'm very sympathetic to the argument that we've dropped way below that trend path in 2020. We self-imposed policies that shut the economy down, and they crashed. And so, I understand some of the aggressive policy. It's not ideal, but I can understand the argument, at least, for why so much stimulus was added in 2020 to get us back up to the trend path. Where I get concerned is when we overshot that trend path by about $2 trillion. And in my mind, yes, most of the increase in the price level up to that point was due to the larger dollar size of the economy.

Bourne: A lot of people, then, respond to me when I [talk] about the role of excessive macroeconomic stimulus. “Well, how did Joe Biden's stimulus— or what the Federal Reserve was doing— cause inflation all around the world?” So, I think it's quite important to note, re-looking at some of the numbers today, that that story is not the same in every country. If you look at the UK, for example, which I was digging into a bit today, I think that their nominal spending path, the pound size of the economy, is only about 2% to 3% above where it would have been based on a whole different range of trends that you can run. Whereas the real economy there has taken a much bigger hit. Real output is something like 6.7% below where we might have expected it to be if it followed the 2010s trend.

Bourne: Now, some of that might be Brexit, some of it might be the pandemic. They did very different policies in terms of paying to keep people attached to particular jobs rather than just giving people money and allowing them to become unemployed and move to other work. Whatever it is, that story about how much we can blame excessive macroeconomic policy is not the same in every country. Certain countries like Japan and Switzerland just didn't really have very high inflation, even though they were hit by the pandemic and these international supply shocks. So, I think that when you look at that and compare across countries, it's very difficult to conclude that these common supply shocks played any more than a temporary role, or at least a modest role, relative to the effect here of excessive stimulus.

Beckworth: Yes, I will share that I am actually working on a little project where we look at above-trend nominal GDP growth, so pound growth, euro growth. And In many cases, yes, there were large supply shocks, but at the end of the day, rapid growth in the nominal size of the economy, above some pre-crisis trend path, is a policy choice. It's a policy choice that governments have to create for that to happen. But what we do in this paper, this note that I'm working on, is we compare the maximum peaks of inflation, and then we compare them to the maximum overshoots of nominal GDP. And there actually is a pattern. Even though the timings are different, there is a pattern that emerges, that's very suggestive, that when there was really high, above-trend inflation, at least some part of it could be attributed to macroeconomic policy across the world. 

Beckworth: One last thing on this point, and that is that even with supply shocks being an important story, there is this underlying issue of, how credible are the central banks? How credible are the governments in particular countries? Because the normal thinking is, look through supply shocks. If inflation goes up because of a temporary [supply shock], look through it. You can do that if you've got a credible policy, if the world economy believes you're going to keep inflation low over the long haul. If you don't have that credibility, then all bets are off. And I think that's an issue that central banks have to wrestle with as well, and not every central bank had the same amount of credibility going into the pandemic.

Bourne: Yes, I agree with that, and I don't think I fully comprehended, until I was editing this book, the asymmetric nature of the inflation targeting regime now, here in the US. Because it seems to me, very peculiar from an economic first principles perspective view, that if you have a big supply shock, negative supply shock, that you'll look through it. But then, if you have a positive supply shock, you wouldn't look through that and allow inflation to be below target, at the same time, when you have higher real output growth. So, I've become more of a proponent of your nominal GDP level targeting as a result of having lived through this inflation.

Beckworth: Yes, you're preaching to the choir here. Well, look, if AI really does become all that it's supposed to become, and we have massive productivity growth, I think that nominal GDP targeting is well suited to handle those type of positive productivity gains. It would effectively share a lot of the real growth widely through lower prices while keeping nominal income stable. Okay, in the few minutes we have left, Ryan, I want to end on this question. So, even though we had high inflation, we had a surge, and even though I'm uncomfortable with the fact that the dollar size of the economy is $2 trillion larger, some have advocated that it was still optimal because we had this sectoral shock.

Beckworth: There was a switch from services to goods. There's a lot of uncertainty, and you needed to run the economy really hot to make sure we got out of the woods. We got to where we should have been. And maybe some of them would have said, maybe not as hot. So, maybe, yes, there was some excess that was done, but it was still good to run the economy hot, because we needed to get through this quagmire, through this awful period. So, yes, there was too much stimulus. Yes, inflation can be explained, a large part of it, by this stimulus. But it actually was an optimal, or close to optimal, approach given where we were, what we were in, and we needed to get to the other side. How would you respond to that frame?

Was the Recent Inflation Surge Actually Optimal?

Bourne: I would say, well, yes, how's that working out for you politically? It's facilitated a world in which one of the presidential candidates' campaigns is openly talking about moving away from central bank independence and having the president involved in determining the monetary stance of the Federal Reserve. So, I think that the public really hate high inflation, and this is something that I've always said to people who've talked about running the economy hot in nominal terms, which is that if you think about the delta of the difference between having unemployment at 5% or 3%, obviously, for that two percentage points of the population, it's massive. But that's still two percentage points of the population. Everybody is affected by inflation.

Bourne: And it's not been a surprise to me that, because inflation affects everyone, it's been the dominant political issue for two years. It's led to a range of, [in] my mind, economically unserious microeconomic policies. I think that it's led to a regression in the public's understanding of these issues, as a result of the incentives at play. Republicans say it's all due to fiscal stimulus now, and Joe Biden calls the inflation, his energy policies and the fiscal stimulus. Democrats say it's all greedy corporations. So, I think we've seen a regression on that. Finally, we've seen this through the loss of credibility, justified or otherwise. We've seen a world where inflation going so high above target has led to a presidential candidate seeing an opening, or at least his team seeing an opening, for talking about revoking Fed independence. So, you can make that argument from a purely economic perspective, but I think that you have to consider the collateral damage that's been done as a result of allowing inflation to go so high relative to the target.

Beckworth: Once again, there are other margins to consider. That's the good answer. There are always other margins, and I agree with you. I think that one can reasonably make an argument, from a pure model perspective, that this may have been close to an optimal response, but that's a very narrow view. It's your point, and I agree with that. I'm very sympathetic [to it]. There [are] elections. Elections have consequences. High inflation has consequences for elections, so, I think that's consequential. But the other thing, though, also, is the debt level, too. A lot of this inflation, I believe, is tied to the fact that we did generate so much debt. Now, some of this debt has been eroded by the inflation, at least the real debt burden of it. But the fact that we're having over a trillion dollars in interest payments on debt— and it's raising concerns about debt sustainability— that, also, is another margin. So, there [are] other areas where that optimal response has consequences that may not be fully captured within the model.

Bourne: Yes, and if we're going to be in a world where, [during] every crisis, we're going to add 20 to 30% of GDP equivalent to the debt level when we're sailing into these fiscal headwinds of the obligations— contingent liabilities, I guess we should call them, from Social Security and Medicare— we're going to be in a very rough situation. It's unclear to me how that ends. Does it end with some sort of fiscal crisis? Probably not, because we do have an independent currency and a central bank. But does it lead with a sacrificing of central bank independence, and monetary dominance, and the Fed trying to keep the government's borrowing costs down, or directly financing government spending? Do we become MMT? These are huge questions, and I really appreciate the fact that your podcast explores them all. I regularly listen, and it's been an honor to be on here.

Beckworth: Well, with that, our time is up. Our guest today has been Ryan Bourne. Ryan, thank you so much for coming on the program.

Bourne: Thank you very much.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.