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Summary of WP/92/83

Author(s):
International Monetary Fund
Published Date:
January 1993
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Summary of WP/92/83

“Credibility Effects of Price Controls in Disinflation Programs” by Pierre-Richard Agénor

Since the early 1980s, several countries (Argentina, Brazil, Israel, Mexico, and Peru) have launched comprehensive anti-inflation programs with extensive wage and price controls. These so-called heterodox programs are based on the idea that inflation displays considerable inertia because of backward wage indexation and lack of credibility. In this regard, controls were used to break the inertial process. Recent analytical studies have, in addition, argued that price controls can help “signal” the commitment of policymakers to a disinflation strategy.

This paper examines whether price controls may indeed enhance the credibility of a stabilization program. The analysis is based on a model that focuses on strategic interactions between the private sector and policymakers. The first part of the paper shows that a partial price freeze constitutes a time-inconsistent policy and is not fully credible. Paradoxically, price controls may lead to inflation inertia. The second part of the paper shows that the authorities may be able to determine the optimal intensity of price controls--that is, the proportion of prices subject to ceilings--so as to minimize the policy loss implied by a discretionary monetary strategy. However, this results in the effective imposition of price ceilings only if the cost of enforcing them is not too high or if the weight attached to price distortions in the policymakers’ loss function is small.

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