Political economist Isabella Weber has sparked a debate on price controls
Last week, the European Central Bank ended nearly a decade of ultra-loose monetary policy. The bank's board, tasked with maintaining price stability, raised interest rates by 0.75%, the largest single increase since its establishment in 1998. The call for price controls ran counter to conventional economic thinking. However, critics warned that higher interest rates would exacerbate the looming recession in Europe. Instead of controlling prices by restricting the entire economy, a less harmful way to tackle inflation could be to directly control the prices of essential goods, such as gas and electricity.
German political economist Isabella Weber (Isabella Weber), a professor at the University of Massachusetts Amherst, started the debate on this issue; last year, she published an article in the Guardian in which she advocated for price controls.
This was against conventional economic thinking; Nobel laureate Paul Krugman called her article “more than silly”. But the stance has now shifted in I. Weber's favour, and the EU, following Germany's example, has even begun to implement the price controls she championed.
EUobserver: You and Sebastian Dullien published an article in the Süddeutsche Zeitung on 12 February, calling for a maximum gas price cap for basic household needs. How and is this moving forward?
Isabella Weber: We still insist that a gas price cap should be set. Based on our calculations, we found that the [inflationary] burden on households is primarily driven by gas. The German government has adopted this proposal, and an expert commission has been established to determine whether a gas price cap is feasible.
Why are price controls a better way to address the problem of inflation than raising interest rates?
To be clear, I have never proposed fully implementing a command economy. Inflation is a very complex problem. Policymakers must sense how to act, but the choice is this: will we exacerbate a recession to lower prices, or will we target inflation directly by introducing wholesale price caps on essential goods, such as gas and electricity?
One of the cornerstones of the criticism is that price caps discourage people from saving energy or switching to renewable energy sources.
It depends on the situation. In the model I proposed, a household would be provided with a base volume of electricity, which the government sets below market prices. If you exceed this, you pay the higher market price. In this way, the incentive to save remains intact. It is also progressive because wealthy people usually consume more energy and have larger homes; of course, there are exceptions. The German government is currently implementing such a scheme, which I think is good. It proves that such a concept is possible. Now the same is needed for gas.
Transport and food are other drivers of inflation linked to high energy prices. How should they be addressed?
The German government recently expanded price caps on train tickets and public transport, which, by the way, was the most popular measure any German government has implemented. Another form of price control was the petrol discount. Train ticket and petrol discounts slightly reduced inflation.
In the case of petrol subsidies, however, it stimulates people to drive more, doesn't it?
I think you can follow the same logic we used in our proposal for electricity or gas price caps: you provide people with a certain base amount per month. It protects people from market fluctuations without motivating them to drive more.
In your book “How China Escaped Shock Therapy”, you describe how the Communist Party gradually transitioned from a command economy to a market economy by controlling the prices of essential goods. It “avoided” the sudden price liberalisation in most former Soviet republics, which led to years of inflation and recession. What lessons can be learned from the current crisis and the transition to a more sustainable economy?
If we look back at the stagflation of the 70s, which is often compared to the current moment, the economic explanation was based on monetarist principles, namely that the explanation for high prices was simple: there is too much money chasing too few goods. Economists stopped studying the causes of price fluctuations. This also determined the operations and thinking of many of our institutions. We do not have the monitoring capacity to properly understand how prices propagate through our system. That is why we need institutions that monitor price developments in these essential markets.
One of the arguments against price caps is that they are a “slippery slope”. If you set a price for gas, why not for everything else?
True, it evokes the absurd argument of [neoliberal economist and theorist Ludwig von] Mises that a milk price control alone would be enough to lead to a “slippery slope” towards a full command economy. The irony is that in many countries the price of milk is actually [controlled]; I mean, it is not controlled. It is not controlled, but at least politically determined, because most countries do not want to destroy their agricultural sectors.
In your book, you describe how ancient Chinese economists distinguished between essential “heavy” products and non-essential “light” products. Interestingly, it was quite fluid and determined by availability. How do you think a modern government should decide which prices to cap and which to leave to the market?
If we look at the price of gas, it is a price that is extremely important for a wide variety of industrial processes that neither you nor I probably knew about before this crisis, right? It is undoubtedly an essential and difficult-to-replace commodity. However, that price has increased tenfold depending on which price benchmark you choose. It is an explosion by any metric. I think in this case, price controls are obviously necessary. The same applies to essential resources needed for the green transition.
How will higher interest rates affect the EU economy?
I follow the situation in Germany the most, and it is absolutely clear that a recession is coming. The question is: how severe will it be? If we look at the United Kingdom, it is forecast that the poorest ten per cent of the population will spend 50% of their income on fuel this winter. Middle-income groups are likely to buy fewer luxury goods. For wealthy people, high energy bills are not a big problem. I think it is telling that, despite the crisis, luxury brands like Macy's are doing quite well, but Walmart, where ordinary people shop, has seen its profits plummet. Another effect is that high interest rates also do not encourage investment – in renewable energy or insulation – which makes the economy more resilient to these major shocks we are facing.
One argument in favour of higher interest rates is that the central bank must support the euro. A weak euro increases the relative price of oil, which is denominated in dollars.
That is true, but it will not change the situation that much. And if you are worried about the high costs of oil imports, then it would be much more effective to set a wholesale price cap on oil, which the G7 has discussed. A strong economy improves the value of the euro on the global market. If the European economy collapses as the recession deepens, that is even worse news for the euro.
Many economists believe the ECB could have prevented inflation if it had raised them earlier.
When I published the article on price controls, many said that inflation would be transitory. I think that partly gives a lot of legitimacy to people who argue that inflation is a problem. I think we should not underestimate the institutional dynamics. The European Central Bank is responsible for controlling inflation. All they can do is raise interest rates. But instead of intensifying the recession, we also need other tools for price management. That is why I have always said that countries must cap gas and energy prices, rather than simply waiting for inflation to subside.