Fed rate hikes haven't curbed inflation much. These policies would work instead, economists say

Alternative measures include price controls and a windfall profits tax.

September 20, 2022, 6:07 AM

A hotter-than-expected inflation report last week dispelled hopes of relief for strained households and rekindled questions about U.S. policy for fighting sky-high prices.

The Federal Reserve has instituted a series of aggressive interest rate hikes in recent months as it tries to slash price increases by slowing the economy and choking off demand. But the approach risks tipping the U.S. into an economic downturn and putting millions out of work.

Moreover, the rate hikes have failed to significantly reduce prices, prompting suggestions of policy alternatives that some economists told ABC News would better address the root causes of inflation, provide relief for struggling consumers and forgo the danger posed by a possible recession.

On the other hand, some economists told ABC News that the Fed's rate hikes are the best tool for fighting inflation but the central bank hasn't increased them far enough. For its part, the central bank is set to impose another major rate hike on Wednesday.

Economists who support policy alternatives propose measures like price controls, a windfall profits tax on some corporations that charge high prices and a dramatic expansion of U.S. production to address supply shortages.

"The inflation over the last couple of years caught a lot of people off guard," Lauren Melodia, the deputy director for fiscal and economic policies at the research group Center for New York City Affairs at The New School, told ABC News. "There's a way in which society wants one solution for something."

Here's what you need to know about alternative policy solutions for fighting inflation:

Price controls

One of the most widely discussed and controversial solutions for inflation is price controls.

The thinking behind it is simple: When prices are pummeling consumers, the government imposes a measure that prohibits companies from selling particular goods above a certain price. Milk could face one price cap, for instance; soap could face another.

Isabella Weber, an economics professor at the University of Massachusetts Amherst and a proponent of price controls, said the limits could be targeted toward specific items that have experienced particularly sharp price increases, especially essential goods like gas and food.

"Price controls help you avoid a price explosion," Weber told ABC News.

There is a precedent for price controls in the U.S. To stem inflation brought about by supply shortages during World War II, President Franklin Roosevelt empowered the newly created Office of Price Administration to cap prices on a slew of products. The move is widely credited with helping to limit inflation during the war, but it also gave rise to a black market for some items.

Decades later, in 1971, President Richard Nixon imposed price controls in an effort to slash inflation and ensure his re-election the following year. The controls remained in place until 1974 but were seen by many as ineffective at reining in price hikes.

The different outcomes in the 1940s and 1970s show that price controls help fight inflation but not in every case, Weber said, adding that price controls only limit inflation temporarily as other fixes address the causes behind the price pressures.

"It's not that price controls always work or never work," she said. "Price controls can work in certain contexts if tailored the right way."

Some economists, however, reject the notion of targeted price controls.

"Every price is connected to every other price in the economy," Catherine Pakaluk, a professor of economics at the Busch School of Business at Catholic University, told ABC News. "If you put certain products at bargain rates in relation to the rest of the economy, they get scooped up even faster and it generates supply shortages."

For example, a price control on milk would prompt shoppers to load up on it and avoid comparatively high items that lack controls, such as meat, Pakaluk said.

The fear of empty shelves carries heightened concern because supply shortages remain a central cause of U.S. inflation and price controls could exacerbate that root problem even further, Pakaluk added.

"The economy is already suffering a really bad situation with shortages," she said.

PHOTO: Federal Reserve Board Chairman Jerome Powell speaks during a news conference in Washington, D.C., July 27, 2022.
Federal Reserve Board Chairman Jerome Powell speaks during a news conference in Washington, D.C., July 27, 2022.
Mandel Ngan/AFP via Getty Images, FILE

Windfall profits tax

Rather than limit prices, some solutions seek to rein in corporate profits.

A windfall profits tax rests on the premise that inflation has resulted in part from alleged price gouging committed by corporations that have reported record profits amid the inflation crisis, such as oil giants.

In theory, a tax on excessive profits should disincentivize profiteering and bring prices down.

Elizabeth Warren, D-Mass., and Sen. Jeff Merkley, D-Ore., backed a bill in May that would empower a federal agency and state attorneys general to enforce a ban on excessive price hikes.

On the whole, economists sharply disagree over the extent to which excessive profits have contributed to inflation. Similarly, economists who spoke to ABC News differed on whether a windfall profits tax would bring down prices.

Benjamin Powell, a senior fellow at the Independent Institute, dismissed the solution, saying it poses the same risk as price controls: exacerbating supply shortages.

"It will just discourage some businesses from supplying goods that are already in short supply," he said.

Melodia, of the Center for New York City Affairs, disagreed. Because businesses seek to optimize profit, the economy needs a safeguard to prevent them from doing so when prices are highly elevated, she said.

"There is so much evidence over the past couple years that corporations have had increased profits across the board – not just in the oil industry," she said. "We don't want companies jacking up prices because they can."

Some economists, however, told ABC News that a windfall profits tax may push prices higher rather than bring them down.

Richard Wolff, an author and professor of economics emeritus at the University of Massachusetts Amherst, said the measure would need additional protections because otherwise it could drive companies to hike prices even more to overcome the losses imposed by the tax.

"What it becomes is an incentive to raise prices," he said.

Ramp up production

Another policy for fighting inflation centers on an expansion of U.S. production in order to address a supply shortage.

At bottom, inflation owes to an imbalance between supply and demand. The surge in demand for goods and labor has far outpaced supply, as COVID-related bottlenecks have slowed delivery times and interrupted services while infection fears have kept workers on the sidelines.

One way to address that imbalance is to dramatically increase supply, thereby bringing it in balance with outsized demand.

Economists who spoke to ABC News largely agreed on the prudence of increased U.S. production but said it would not address immediate inflation, since the necessary output overhaul would take several years.

"It's the most important thing we could be doing if we want sustained growth without price pressure," J.W. Mason, a professor of economics at John Jay College, told ABC News. "We should be investing in capacity."

The policy approach will likely take several years, he added.

"It's not an immediate or short-term solution," he said. "Obviously, it's not going to limit price increases over the next months or year."

Powell, of the Independent Institute, shared the support for increased U.S. production but opposed public investment. Instead, he said the U.S. should remove current policies that impede private sector growth.

He said he supports "lowering taxes and regulatory barriers that prevent entrepreneurs from bringing new investment."

Regardless of where they stood on particular policies, several economists told ABC News that the U.S. needs a robust public dialogue about whether to pursue further rate hikes or explore alternatives.

"It's a big fat mess," said Wolff. "There should've been a debate before launching into interest rates. There should've been a discussion between political leaders and the public."

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