Thursday

6th Oct 2022

Interview

'We need different tools to deal with inflation'

  • Political economist Isabella Weber launched the debate over price controls (Photo: Isabella Weber)
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Last week the European Central Bank ended nearly a decade of ultra-loose monetary policy.

Tasked with keeping prices stable, the bank's governing council raised interest rates by 0.75 percent, the largest single increase since its founding in 1998.

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  • Calling for price-controls went against established economic thinking (Photo: Fotolia)

But critics have warned higher interest rates will exacerbate a looming recession in Europe. Instead of managing prices by suppressing the entire economy, a less damaging way of dealing with inflation may be by directly controlling the prices of essential goods like gas and electricity.

German political economist Isabella Weber, a University of Massachusetts Amherst professor, launched the debate when she published an article advocating for price controls last year in the Guardian.

This went against established economic thinking, with Nobel laureate Paul Krugman calling her article "beyond stupid."

But consensus is now shifting in her favour and the EU, following Germany's lead, has even moved to implement the type of price controls she has advocated for.

EUobserver: On 12 February, you and Sebasient Dullien published an article in the Süddeutsche Zeitung calling for a cap on gas for households' basic needs. How is that going?

Isabella Weber: We are still pushing for a price cap on gas. Based on our calculations, we found that [inflationary] burden for households comes mostly from gas. The German government has taken up the proposal and an expert commission to determine whether it is possible.

Why are price controls a better way to address inflation than increasing interest rates?

Just to be clear, I never proposed a full command-economy. Inflation is a highly complex problem. Policymakers will have to feel their way forward, but the choice they are confronted with is: do we exacerbate the recession to bring down prices or directly target inflation by instituting a wholesale price cap on essential goods like gas and electricity?

One line of criticism is that price caps disincentivise people from energy-saving or switching to renewables.

That depends. In the model I proposed in February, a household would get the basic amount of electricity set below market prices by the government. If you go above that, you pay the higher market price. In that way, the price incentive to save remains intact. It is also progressive because rich people usually use more energy and have bigger houses, although exceptions exist. The German government is now implementing such a scheme, which I think is good. It establishes that such a concept is possible. Now the same thing is needed for gas.

Transport and food are other drives of inflation, which are linked to high energy prices. How to address those?

The German government recently extended the price ceiling on train tickets and public transportation, which was, by the way, the most popular measure that any German government has implemented. The gasoline discount was also a form of price control. Inflation was brought down slightly because of the discount on train tickets and gasoline.

In the case of a gasoline subsidy, this does incentivise people to drive more, right?

I think you can follow the same logic we applied to our proposal for a cap on electricity or gas: you provide people with a base amount a month. This protects people against volatile markets without incentivising them to drive more.

In your book How China Escaped Shock Therapy, you describe how the communist party gradually transitioned from a command economy towards a market economy by controlling the prices of essential commodities. It 'escaped' the sudden price liberalisation in most former Soviet republics, which resulted in years of inflation and recession. What lessons can be transposed to our current moment of crisis and transition towards a more sustainable economy?

If you look back at the 1970s stagflation, to which our current moment is often compared, the economic narrative was settled in monetarist terms, meaning the explanation of high prices was simply too much money chasing too few goods. Economists stopped studying the reason for price swings. This also determined how many of our institutions work and think. We do not have the monitoring capacity to understand how prices percolate through our system right. So we need institutions that monitor price developments in these essential markets.

One of the arguments against price caps is that it's a slippery slope. If putting a price on gas, why not on everything else?

Right, this harks back to [neoliberal economist and theorist Ludwig von] Mises' absurd argument that controlling the price of milk alone was enough to go down the 'slippery slope' towards a full command economy. The irony is that in many countries, the milk price is actually [controlled]; I mean, it's not controlled but at least politically-determined because most countries don't want to ruin their agricultural sectors.

In your book, you describe how ancient Chinese economists distinguished between essential 'heavy' products and non-essential 'light' goods. Interestingly, this was quite fluid and was determined by availability. How do you think a modern government should decide which prices to limit and which to leave to the market?

If we look at the price of gas, then this is a price which is extremely important for a whole range of industrial processes that probably neither you nor I were aware of before this crisis, right? It's clearly an essential hard-to-replace good. Yet, this price has multiplied by ten, depending on which price benchmark you take. It's an explosion by any measure. I think this is a case where price controls are obviously needed. The same goes for essential resources required for the green transition.

Interest rates

How will higher interest rates affect the EU economy?

I follow the situation in Germany the closest, and it's pretty clear a recession is on the cards. The question is: how bad is it going to be? If you look at the UK the poorest ten percent are projected to spend 50 percent of their income on fuel this winter. Middle-income groups will probably buy fewer luxury products. For rich people, high energy bills are not a big deal. I think it is telling that luxury brands like Macy's are doing quite well despite the crisis, and profits for Walmart, where ordinary people shop, has plummeted. Another effect is that high interest rates also disincentivise investments — in renewables or insulation — that make the economy more resilient to these great shocks we are dealing with.

One of the arguments for higher interest rates is that the central bank needs to support the euro. A weak euro increases the relative cost of oil, which is denominated in dollars.

That's true, but it won't make that much of a difference. And if your concern is the high import cost of oil, then it is much more effective to have a wholesale price cap on oil, as has been discussed by the G7. A strong economy improves the euro's value on the global market. If by exacerbating the recession, the European economy collapses, this is even worse news for the euro.

Many economists believe the ECB could have prevented inflation if it had raised it sooner.

When I published the price controls piece, many said inflation would be transitory. I think this is part of what gives a lot of legitimacy to the people who say inflation is a problem. I also think that one should not underestimate the institutional dynamic. The ECB is in charge of inflation control. All they an do is raise interest rates. But instead of exacerbating a recession, we also need different tools to manage prices. That is why I have always said states need to cap gas and energy prices instead of just waiting for inflation to subside.

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