General Economic Concepts
What is Policy?
History of Macroeconomic Policies in the United States
Policy Goals: Maximum Employment
Policy Goals: Maximum Production
Policy Goals: Price Stability
Policy Goals: External Balance
Subsidiary Policy Goals
Conflicting Policy Goals
The Policy Makers
The Policy Instruments
The Decision-Making Processes
The Policy Indicators
The General Economic Model
Monetarist Monetary and Fiscal Policies
Keynesian Monetary and Fiscal Policies
Debt Management Policies
Supply Management Policies
The Long Wave
- Wage and Price Controls
- Tax-Based Incomes Policies (Tax-Based Incentive Plans)
- General Problems
Incomes policies — wage and price controls, tax incentives, indexing, or other measures to fix income shares — are generally used to control inflation. Governments very often resort to wage and price controls during wartime to minimize war-induced inflations. The U.S. government imposed such controls during World Wars I and II. However, economies are increasingly experiencing high peacetime inflation rates and, while wage and price controls are one solution, adherence by participants is difficult to obtain, unless the country is in a state of national emergency. As a result, economists have proffered some alternative inflation-fighting incomes policies that persuade — rather than coerce — participants into compliance.
The theory behind incomes policies is that inflation is cost-induced. Workers seek higher wages. Investors seek higher interest rates. Landlords desire higher rents. Owners want more profits. As each group seeks to raise its position in the income distribution, costs rise and prices rise. As prices rise, real income falls, and the cycle starts over with each group attempting to increase its own income. What is needed is a mechanism for stopping the upward cost-price spiral in its tracks.
II. Wage and Price Controls
Types of Wage and Price Controls
Absolute Controls The government can set or "freeze" the absolute level of wages and prices to fix income shares. In an inflationary period, the frozen wages and prices are the maximum prices to be paid. In a deflationary period, the frozen wages and prices are the minimum prices to be paid. The most ubiquitous minimum price, however, is the minimum wage. Although the government has imposed minimum prices in some individual markets, wage and price controls are generally maximums, above which participants may not trade.
Rate of Growth Controls The government can set or "freeze" the annual percentage changes for wages and prices to ensure that income shares remain fixed over time. In an inflationary period, the annual percentage increase in wages and prices is limited to some maximum rate of increase. In a deflationary period, the annual percentage decrease in wages and prices is limited to some maximum rate of decrease.
Legal Implications of the Controls
Voluntary Controls Very often, especially in a peacetime inflation, the government will set benchmarks for pricing behavior. Since these benchmarks are not legally binding, firms may adhere to or violate the controls as they see fit. Voluntary controls are "guidelines" or "guideposts" rather than hard and fast rules legislated by the government. Generally, voluntary controls are supported by "jawboning" or excessive verbal pressure on firms by the government to adhere to the "guidelines".
Mandatory Controls If "guidelines" or "guideposts" prove unworkable, the government may legally force firms to adhere to the controls. Mandatory controls are legislated rules for wage and price behavior and may or may not come with penalties. If there are no penalties, then violation becomes the rule and adherence is the exception. If there are penalties, adherence or violation of the controls depends upon the excess of benefits from violation over the costs of the penalties, if caught.
Advantages and Disadvantages of Wage and Price Controls
Imposition immediately caps wages and prices to defuse inflationary expectations and to stop an inflationary (deflationary) wage-price spiral The effects of monetary and fiscal policies are typically spread over a long period and the action to stimulate or slow the economy with these policies may be totally inappropriate by the time the effect is felt. Rather than waiting for monetary and fiscal policies to filter through the market place to adjust aggregate demand, wage and price controls are effective upon enactment by congress, or in the case of an emergency, by Presidential order.
Imposition increases real income
Absolute controls If wages and prices are fixed, no one group can raise its income, except by working longer and producing more. This increases real output at current wage and price levels to increase real income. With an increase in real income, presumably, the groups will stop fighting to raise their individual nominal incomes and the wage-price spiral will be broken.
Rate of growth controls If wage and price increases are fixed, no one group can raise its income faster than the others, except by working longer and producing more. This increases real output, while price increases are controlled. With an increase in real income, presumably, the groups will stop fighting to raise their individual nominal incomes and the wage-price spiral will be broken.
Wage and price controls distort the pattern of resource usage If supply and demand are unbalanced in the various markets, bottlenecks, shortages, and surpluses will develop. This occurs because the setting of maximums (minimums) often implies the setting of minimums (maximums).
Differential market demands In some markets, demand will be rising faster than the allowable wage and price increases and in others demand will be rising slower or, perhaps, falling. If all wages and prices are raised (lowered) by the maximum amount, shortages will develop in markets where demand is rising faster and surpluses will develop in markets where demand is growing more slowly or falling.
Wage and price controls distort the composition of real output
Differential productivity gains In some markets, productivity will be rising faster. In these markets, labor is entitled to wage increases in excess of the controlled increases. If they are not permitted, productivity gains may be offset by worker apathy as income is transferred to owners.
Shortages In markets where demand is rising or where the prices of non-labor inputs are rising, firms will be unwilling or unable to produce more, either because they cannot bid up wages to attract more labor or because they find production unprofitable at the controlled prices. This excess demand creates bottlenecks and shortages. Sometimes the government must resort to formal rationing of certain goods. Shortages tend to breed "black markets" where higher prices reflect the real value of resource usage.
Wage and price controls suppress inflation, but do not cure it If demand continues to rise, despite the controls, inflation is subdued, but not eliminated. Excess demand creates inflationary pressures underneath the controls. If nothing is done to eliminate excess demand in the various markets, removal of the controls will permit prices to rise to market levels. In the short-run, this will raise the inflation rate above previous levels, until all excess demand has been eliminated. As the inflation rate soars, participants may become disillusioned by the return of inflation, inflationary expectations will be restored, and the wage-price spiral resumed.
Surpluses In markets where demand is falling, prices may not fall — they will be stuck at the "frozen" level. Surpluses, and eventually, unemployment, result. Even with flexible controls, where wages and prices are allowed to rise (fall) by some percentage, the same bottlenecks, shortages, and surpluses will develop. These inbalances arise, because (1) demand does not increase proportionally across-the-board in all markets, (2) productivity does not change by the same percentage across all firms in all industries, and (3) technological change does not proceed evenly among all firms in all markets.
Wage and price controls require yet another government bureau for policing economic behavior and enforcing the controls Either the Congress must legislate, or the President may appoint a council or commission to promulgate and enforce the controls, e.g. President Carter's Wage and Price Control Council.
III. Tax-Based Incomes Policies (Tax-Based Incentive Plans)
Rather than control wages and prices directly, the government can influence firms' wage and price behavior indirectly through the use of tax-based incomes policies or tax incentives rather than through mandatory laws and fines. With TIPs, the penalty for violation is loss of the tax incentive. Firms that keep their wages and prices below guideline levels are rewarded with tax credits or reductions in tax liabilities. Such rewards vary directly with the degree of compliance. Firms that choose not to comply with the guidelines are assessed tax penalties that vary directly with the degree of violation. As with mandatory controls, compliance depends upon the benefits and Costs to economic participants. If the rewards and penalties are in line with compliance and violation, then compliance becomes the rule. If rewards and penalties are not in line with compliance and violation, then violation becomes the rule. Additionally, such a scheme is effective only so far as the added cost to employers of granting pay increases strengthens their relative bargaining power in resisting wage claims.
With indexing, prices are generally allowed to vary with market conditions. Then, all factor incomes — wages, interest, and rent — are indexed to the price changes so that the income shares remain fixed over time. In an indexing scheme, cost increases are indexed at some fraction of the price increases. For example, the index factor may be 0.8. If prices rise by 10%, costs may rise by only 8%. This means, in theory, that prices will rise in the subsequent round by only 8%. If costs are still indexed at 0.8, then costs may rise by only 6.4%. This fractional indexing scheme should pull down inflation at the next round to 6.4%; and so on.
V. General Problems
All incomes policy measures presume that the income shares that exist at the time of imposition of the incomes policies — the current distribution of income — are the desired income shares. If they are not, then the incentive to violate the policies increases.
All incomes policy measures require an adequate means for policing the pricing activities of firms, a strict and impartial enforcement agency, and suitable rewards and penalties to influence the appropriate behavior. In general, they require another layer of government or a government agency to oversee their execution. To the extent that government resources are limited, not all sectors of the economy can be monitored effectively. This failure would encourage a shift of resources from policed areas to non-policed areas and thus encourage circumvention of the policies.
All wages and prices, including imports, must be controlled. Otherwise, prices in the uncontrolled markets are allowed to rise and fall faster than the prices in the controlled markets and this leads to factor income imbalances that lead to failure of the program.
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