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"In world of overlapping emergencies we need new forms of price stabilization"

Paolo Gerbaudo

10 mins - 30 de Julio de 2022, 07:00

"Price controls on oil and gas are a necessary emergency response to the energy crisis. But the problem is structural and they are only a measure to buy time". A young economist at a the University of Massachusetts Amherst, Isabella Weber, has already made a name for herself as part of a generation of new economists breaking with old neoliberal dogmas. First with her award-winning book of How China Escaped Schock Therapy (2021), then an op-ed article she wrote for The Guardian in late December 2021, sparked a huge debate, with mainstream economists attacking her fiercely for wanting to interfere with the price mechanism which they consider sacred. Yet, since the war in Ukraine many of these critics had to correct their position. Price controls on energy are now being openly discussed, with countries like France setting a ceiling on energy prices, and European Union members have recently agreed on a cap on consumption. Yet, as Weber highlights, much more needs to be done to address the present situation, considering that this is not a one-off but more systemic in a world of overlapping emergencies in which climate change and geopolitical disarray are bound to generate a wave of price shocks. Governments should establish agencies capable of monitoring the supply of essential materials in real-time, while considering bringing some of these sectors under greater public control.


Paolo Gerbaudo.- After the Great Moderation we are now once again facing inflation, a trend that has taken many economists by surprise. People are drawing historical parallels with the 1970s. When can we find guidance to understand the current situation and how to deal with it? 

Isabella Weber.- It's a combination of different factors and we should consider a series of historical parallels rather than just one. Perhaps the closest parallel is between the inflation after World War II and the transition out of the COVID-19 shutdowns. As I show in my book, during the war there were strict regulations on what could be produced, prioritising productions that were strategic for the war effort. Once the economy opened up you had bottlenecks forming, as people went back to non-war related consumption and investment, and this led to price increases on products that had been restricted during the war. Similarly, as the pandemic started to ease people went back to purchasing goods that they had not purchased during the lockdowns. This was enabled by the fact that some had managed to save money over that period but the purchasing power that they had acquired was rapidly depleted by rising prices. After some time, these supply bottlenecks tend to ease as it happened after World War II, the inventory starts to be replenished, and prices lower. This can lead to a turning point in a boom-and-bust cycle. Lower demand due to eroded purchasing power meets easing supply. 

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P. G.- Yet now inflation is not just one related to supply disruption. It has been compounded by a severe energy inflation caused by the war in Russia. How does this change the situation? 

I. W.- Already before the war we had price hikes and evidence of a new commodity price cycle. Price signals failed to adjust demand and supply already in the fall 2021. Since the war this situation worsened, with price shocks not only in energy, but also in food and raw materials. In some ways this is reminiscent of the oil shocks during the 1970s, though perhaps now the situation is even worse. As the economic war intensifies, some economies that were particularly dependent on Russian supply such as the German economy might end up can sleepwalking into a form of shock therapy. As I show in my book How China Scaped Schock Therapy, a deen schock to the industrial backbone of the economy was at the heart of schock therapy and shook the foundations of the economies that implemented it. Such a schock could severely hurt workers and firms. On top of the price shocks, we are at risk of having actual gas shortages in Europe in the fall, this will have wide-ranging implications for the whole economy that are extremely difficult to predict. A situation of fundamental uncertainty where the possibility of a disaster looms large. 

P. G.- Right-wing politicians such as Christian Lindner in Germany are now calling for austerity measures in order to address inflation. But are monetarist responses such as those that were pursued during the 1970s going to solve the situation? 

I. W.- I think that to understand the current inflationary situation we need to overcome monetarist understandings of how the economy works, which lay excessive emphasis on the quantity of money and aggregate demand, without paying sufficient attention to the given structures of the real economy and the role of basic inputs such as oil and gas that cannot easily be replaced in the short run. This is something that also the New Keynesian paradigm does not fully account for. It suggest that until you do not reach full capacity utilization in employment and capital, you do not get significant inflation. But that overlooks shortages of basic materials. If you have bottlenecks in inputs that are essential to production across sectors you can reach capacity limits long before you reach aggregate capacity utilisation. Most people looking at inflation thought that this would be transitory and we didn’t need to worry. But this underestimated the importance of such essential materials and input/output relationships and the far-ranging cascading effects that schocks to essentials unleash. It also overlooks the fact that even if inflation was to go away again on its own after some time, price spikes in essentials like food and fuel hit households in the lower parts of the income distribution extremely hard. Some sectors need more redundancy, more buffer stocks to absorb the schocks avoid the shortages that we are currently experiencing. 

P. G.- To what extent is what we are experiencing an exception or the shape of things to come? A deglobalizing world in which cheap supply of labour and materials become less guaranteed, and marked by environmental disasters will mean ongoing inflationary pressures? 

I. W.- In a deglobalizing world we risk dealing with enormous price shocks and dominant economic theory is not preparing us to deal with this. Deglobalisation can be an inflationary force especially if it happens in a chaotic manner. We have an extremely interconnected global economy in which many countries are dependent on monocultural exports. If trade is disrupted this can lead to supply issues, rising prices due to rising costs or simply reflecting temporary scarcities and pricing power. On top of that we need to consider the long-term impact of climate change. Because of high temperatures we can have negative effects on basic infrastructure, such as roads melting, and there are all sorts of industrial processes that need to happen within a certain temperature band. Climate change and extreme weather events can cause or exacerbate supply chain issues. Before the current multifaceted crisis, globalisation was dominated by just-in-time production networks. If demand went up, supply could easily follow and prices were remarkably stable. But now you have the opposite situation. If supply networks are not operating just in time anymore, when supplies stop flowing prices rise. In face of sector wide supply disruptions, the dynamic of competition switches from competition for market shares, to a dynamic of competition which prioritises charging higher prices for available inventories and this can be a further inflationary factor. 

P. G.- You have proposed selected price controls against inflation as a measure to overcome the crisis, and you were criticised by many economists. Could you explain how price controls can help overcome the present difficulties? 

I. W.- When I was making the point back in December 20221 we were already in a situation where we had already had sharply rising prices driven by intensely sectoral dynamics. In response to price signals we did not have an adequate increase in supply due to the wide ranging disruptions from the pandemic and the looming geopolitical tensions. Is supply of a good faces physical barriers like a blocked port, it does not go up when the price increases as the textbook would suggest. At the time, many were still thinking that we would soon go back to some sort of pre-pandemic normality. With the war, the reality that no return to pre-pandemic normality is in sight has caught up with many people.

My proposals has been to apply carefully selected and designed price controls to stabilize essential prices like gas in order to buy time for measures that adjust demand and supply. By now European policymakers like von der Leyen are discussing a wholesale price cap on gas, which would be an agreement among European buyers of gas to not to buy above a certain proce. Janet Yellen has promoted an internationally coordinated cap on oil which has also been discussed at the G7. So, the idea of direct price stabilization has arrived in the mainstream of economic policy making. The EU gas price limit  would need to be combined with a EU level saving programme as has just been proposed by the Comission. Further, we need to guarantee a basic amount of gas to all households at a controlled price, as I have been arguing since February. Higher market prices for gas consumption above that guaranteed amount can provide incentives to save gas. This dual-track pricing logic is developed at lenght in my book based on the Chinese example. But in any case, price controls are not the long-term solution to the problem. They are always just an emergency measure to buy time. It is like putting a bandage when someone someone is bleeding from the arm. Yo still need to bring the person to the hospital. If you don’t do anything to bring back supply or adjust demand, the problem will drag on.

P. G.- What is then the long-term solution to present problems? What should governments do? 

I. W.- We need to accept that in a world of climate change and disintegration of the global order, a world of epidemic diseases and so on, central banks and fiscal policy alone are no longer capable to stabilise and economy by themselves. We need new policy institutions that have the capability to monitor essential sectors. Policy makers need to have the ability to monitor the situation in important sectors in real-time instead of having that information once a year. This is a low-hanging fruit, namely something that could fairly easily be implemented. But this information is only useful, if you also have the sectorial expertise and state capacity to react shocks in these important sectors. The supply chain task force of the Biden administration has started to operate based on such a sectorial logic. But we need to generalise this approach and be prepared for targeted emergency stabilisation. We need economic disaster preparedness to guarantee that we are able to react to shocks in sectors that are important for the work of hole economy. These are stabilization measures needed in our age of overlapping emergencies. This kind of stabilization not only preserves real wages but also purchasing power and can as such play and important role for macroeconomic stabilization. If you have no policy tools  to react to sector specific shocks, but react with macroeconomic tightening, you are kind of throwing out the baby with the bath water. Instead of tackling the issues where they emerge, you end up pushing down the whole economy. This is not a sustainable policy strategy, especially when schocks become more systemic.
(Here, the Spanish version)
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