Incomes policy
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In economics, incomes policies are wage and price controls used to fight inflation.
Such policies were widely used in the 1960s and 1970s as a method of fighting stagflation.
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[edit] Explanation
Incomes policies vary from "voluntary" wage and price guidelines to mandatory controls like price/wage freezes. One variant is "tax-based incomes policies" (TIPs), where a government fee is imposed on those firms that raise prices and/or wages more than the controls allow. This is seen as internalizing the external cost of raising prices and/or wages, solving a market failure that encourages inflation.
Some economists agree that a credible incomes policy would help prevent inflation. However, they would have other effects. By arbitrarily interfering with price signals, they provide an additional bar to achieving economic efficiency, potentially leading to shortages and declines in the quality of goods on the market, while requiring large government bureaucracies for their enforcement.
Some economists argue that incomes policies are less expensive (more efficient) than recessions as a way of fighting inflation, at least for mild inflation. Yet others argue that controls and mild recessions can be complementary solutions for relatively mild inflation.
The policy has the best chance of being credible and effective for those sectors of the economy dominated by monopolies or oligopolies, particularly nationalised industry, with a significant sector of workers organized in labor unions. These institutions enable collective negotiation and monitoring of the wage and price agreements.
Other economists argue that inflation is essentially a monetary phenomenon and the only way to deal with it is by controlling the money supply, either directly or by means of interest rates. They argue that price inflation is only a symptom of previous monetary inflation caused by central bank money creation. This view holds that without a totally planned economy the incomes policy can never work, because the excess money in the economy will greatly distort areas which the incomes policy does not cover.
[edit] Incomes policy in the United States
During World War II, price controls were used in an attempt to control wartime inflation. The Roosevelt administration instituted the OPA (Office of Price Administration). That agency was rather unpopular with business interests and was phased out as quickly as possible after peace had been restored. However, the Korean War brought a return to the same inflationary pressures, and price controls were again established, this time under the OPS (Office of Price Stabilization).
In the early 1970s, inflation had been much higher than in previous decades, getting above 6% briefly in 1970 and persisting above 4% in 1971. U.S. President Richard Nixon imposed price controls on August 15, 1971. This was a move widely applauded by the public and some number of (but by no means all) economists. The 90 day freeze was unprecedented in peacetime, but such drastic measures were thought necessary. Also motivating the controls, it should be noted that on the same date that the controls were imposed, 15 August 1971, Nixon also suspended the convertibility of the dollar into gold, which was the beginning of the end of the Bretton Woods system of international currency management established after World War II. It was quite well known at the time that this would likely lead to an immediate inflationary impulse. The controls aimed to stop that impulse. The fact that the election of 1972 was on the horizon likely contributed to both Nixon's application of controls and his ending of the convertibility of the dollar.
The 90 day freeze became nearly 1,000 days of measures known as Phases One, Two, Three, and Four, ending in 1973. In these phases, the controls were applied almost entirely to the biggest corporations and labor unions, which were seen as having price-setting power. With such monopoly power, even economists saw controls as possibly working effectively (though they are usually skeptical on the issue of controls). Because controls of this sort can calm inflationary expectations, this was seen as a serious blow against stagflation.
Such supply-side controls are well known to have serious limitations. Crucially, they lead to shortages of many goods and to declines in the quality of products (as a way to get around the controls). This is why macroeconomists argue that price and controls must be combined with restraint on the aggregate demand side. Unfortunately, Nixon and (at the Federal Reserve) Arthur Burns did exactly the opposite of what economists recommend. Their policies encouraged increased aggregate demand during 1971 and 1972. So the worst predictions of the skeptics became true and the controls were abandoned (about the same time as the Bretton Woods system was finally abandoned).
Since that time, the U.S. government has not imposed maximum prices on consumer items or labor.
