Traditional microeconomic analysis shows that effective price ceilings below the market equilibrium level result in excess demand, nonprice rationing, and misallocation of resources. However, despite these well-known inefficiencies, price controls have been used repeatedly in the context of stabilization programs in developing countries.
This paper examines the interactions between political and economic factors that contribute to the implementation--and eventually the removal--of price controls. It focuses, in particular, on the role of elections and the cohesiveness of party coalitions. The analysis shows that, to the extent that macroeconomic outcomes affect voters’ behavior, an incumbent seeking re-election will attempt to secure, before the electoral contest, the short-term political advantage of the lower rate of inflation brought about by price controls. Immediately after the election, the macroeconomic losses associated with price controls assume greater importance at the same time that the potential political gains from imposing such controls tend to dissipate. Hence, prices are adjusted sharply upward. However, with backward-looking wage contracts, controls are tightened rather quickly afterward because past inflation rates tend to have a larger effect on the current rate.
When uncertainty about the term in office prevails--a situation that may occur if the incumbent represents a coalition of political parties, which may collapse at any given moment--price controls tend to be used less intensively over the electoral cycle.