This past week, I was a little under the weather with a cold. A few weeks before, my son got very sick when his cold transformed into some infection that sent his temperature soaring. So, I made sure to monitor my own temperature closely, and thank goodness, it never really crept above 98.6 F. What does a temperature have to do with economics? Well, it is just an analogy. But for what?
I came across this article from the Buenos Aires Herald on how the government in Argentina has strong armed many of the top supermarket chains in Argentina to freeze their prices for two months. A big part of the impetus for these price freezes is that in recent months, prices have risen between 2.6 and 2.9% per month, or an average of 2.75% per month. If prices keep going up an average of up 2.75% per month for 12 months, that annual price rise is a whopping 38.5% inflation rate. Consider this, no one will want to lend out money at a rate any lower than that annual inflation rate, or they would lose buying power. That is, after a year of inflation of 38.5%, it will now take $138.50 to buy what you could have bought a year earlier for $100. At inflation rates that high, everyone will want to get paid more often so that they can spend right away, before their money loses any more of its value.
Price freezes, if enforced by the government, will only result in severe shortages. Think about the availability of bread, water and gasoline at stores 24 hours before a hurricane is supposed to hit. Or think gasoline and ice a few days after a hurricane has hit.
If I were a grocer, I would not want to restock if the prices I was buying at kept going up and up while selling prices were frozen? Keep in mind that grocers’ markups, at least in the US, are only about 2%.
What is going on in Argentina is not too different than what is happening here as far as deficit spending. When governments spend well more than they bring in in taxes, one of the ways that they pay for that deficit is by creating more money, in some places that is with printing presses. If the money in the system grows faster than production, prices go up.
Increasing the money in the system because politicians want to spend more than they take in, causing inflation and then resorting to price controls to keep prices from going through the roof has happened across the centuries, and with the same effect, severe shortages. For instance, Roman emperors often debased their currency, clipping off some of the silver in the coins to make new coins. In 301 AD, Emperor Diocletian, after currency reforms that resulted in inflation, issued a famous edict that froze prices, with predictable results: shortages and black markets. (Coincidentally, one of Diocletian’s currency reforms was the creation of several new coins, one of which was the argenteus, sharing a root with the name Argentina, both from the Latin word argentum, translated as silver, the metal used in the easily debased denarius.)
Inflation cannot be eliminated by putting limits on prices. Increasing prices never cause inflation – higher prices is inflation, and the cause is increasing the money supply. Diocletian did not understand this, nor do many leaders today.
Holding retail prices constant with price controls, when the natural or equilibrium price is higher, only creates shortages, as Diocletian found out and as we will soon see in class. Freezing retail prices to bring down inflation is like trying to cure an infection by sticking your thermometer under cold water to cure your infection.