Nuances and Difficulties of Price Control

If the Bank of Japan (BOJ) were able to adjust the money supply and interest rates independently, it might be possible to reduce the overall price level or at least to curb rising prices by controlling the quantity of money. At the same time, keeping interest rates low could prevent the prices of government bonds from falling and perhaps also maintain stock prices at a high level. The concept of equilibrium in the money market is crucial within the fields of macroeconomics and economic policy theory, as well as in the field of fiscal policy, which I teach. Those who have studied macroeconomics may have learned about the LM curve. In these fields, the BOJ is understood to use interest rates as the instrument for controlling the money supply. Of course, the reverse is also true. In courses on economic policy, though it may not be taught in recent years, there is a principle known as Tinbergen's rule. This rule states that for each policy objective, at least one policy instrument is required. In this sense, the money supply and interest rates can be said to constitute a single policy instrument.

Those who have studied economics may also be familiar with the term "trade-off." This refers to the idea that between two policy objectives, an attempt to improve one will lead to a deterioration in the other. Following this line of reasoning, if the BOJ uses a single policy instrument to alter its policy target (in this case, the price level), then controlling the money supply and controlling interest rates stand in a trade-off relationship. Consequently, if the BOJ wished to adjust both simultaneously, another policy instrument would be necessary. Put differently, if the BOJ wished to address price stability by using the money supply, while at the same time seeking to maintain the prices of government bonds and equities through the use of interest rates, then it would need a policy instrument in addition to the money supply and interest rates. This need could be fulfilled by fiscal policy conducted by the government. If the government aims to reduce prices by contracting the money supply, the most effective approach would be to run a fiscal surplus and thereby absorb money held by the private sector. Conversely, if the government seeks to keep interest rates low, it should adopt a policy of purchasing government bonds circulating in the market, raising their prices and thereby holding down their yields.

The discussion in this article thus far may leave readers feeling somewhat puzzled. In order to pursue measures against rising prices while simultaneously maintaining the prices of government bonds and equities, the available options appear to be limited to the following combinations. One possibility is that the BOJ reduces the money supply. In other words, it sells the government bonds it holds, which would normally drive interest rates upward, while the government counteracts this by purchasing the bonds put up for sale, thereby preventing interest rates from rising. Another possibility is that the BOJ increases the money supply in order to keep interest rates low, while the government absorbs the resulting increase in money. This would most likely be accomplished through taxation, which would probably be the quickest method.

It is impossible to predict what kinds of economic measures those involved in politics will be proposing by the time this article reaches readers. Even so, contemporary economics teaches us that when it comes to addressing rising prices, options such as distributing cash indiscriminately or implementing tax cuts do not appear anywhere among the appropriate policy choices.

Of course, among readers, there may be some who are indifferent to declines in the prices of government bonds or equities. This raises two issues that everyone must consider. First, do you know that the public pensions that many of you pay, as well as the private retirement savings you manage individually (often in the form of investment trusts), invest in government bonds or equities? Those who are concerned about their future pensions may be attentive to how the Government Pension Investment Fund (GPIF) manages its funds. If the prices of government bonds or equities decline, retirement funds will diminish. The second issue to be aware of is that when government bonds can be sold at high prices, this is equivalent to the government being able to issue bonds at low interest rates. In other words, if bond prices fall, the government may manage with the bonds it is currently issuing, but when it seeks to refinance those bonds at maturity, it will have to issue new bonds at interest rates higher than those on the maturing bonds. Consequently, the annual interest payments from that point onward will increase. For example, if the interest rate rises from 1% to 2%, the interest payments will double, and the government must find a source of funds to cover this increase. The government is then faced with the need to consider either raising taxes or reducing fiscal expenditures. Even here, it seems unlikely that the government would have the leeway to implement tax cuts or direct cash payments. Of course, some might argue that interest payments could be covered by issuing additional government bonds. However, doing so would further depress bond prices and cause interest payments to escalate in a snowballing manner. Up to this point, it appears that options such as direct cash payments or tax cuts are simply not available to the government.

From the academic perspective of economic theory, the first step is to consider why prices have risen. From the standpoint of economic policy, the question becomes whether the government truly needs to intervene to control prices. One possible approach is to tolerate price increases while implementing policies that ensure wages and incomes rise sufficiently to keep pace with inflation. This line of thinking may naturally lead to proposals such as direct cash payments or tax cuts to increase take-home pay. However, as we have already considered, these raise a host of further issues. While the government could, in principle, request that companies raise wages, would such an approach be effective? One can easily imagine that SMEs would be unable to do so. If such issues exist, why did the idea of price control measures arise in the first place? Presumably, it was because the rising prices of goods were making people's lives difficult. Nevertheless, from the discussion so far, it becomes clear that when it is difficult to lower overall prices or curb their rise, the only feasible approach may be to shift the perspective and stop attempting to subsidize everyone. The question then becomes who requires financial support. Citizens facing poverty may be in situations where even basic subsistence is threatened. In extreme cases, their very lives may be at stake. This is typically referred to as support for low-income individuals. However, it is more precise to define this category as people faced with poverty, since individuals with assets can draw on them even without income. Even so, this article will use the terminology of "support for low-income individuals" for the sake of intuitive clarity. Building on our discussion thus far, a way to organize our thinking is to discard the notion that the government should implement measures to control prices. Instead, the remaining viable approach appears to be a shift in perspective: the government should focus on policies supporting low-income individuals in response to rising prices. From this standpoint, the government's role becomes clear. More precisely, the focus should be on those confronting poverty. In practice, this means low-income individuals who pay little or no income tax and for whom tax cuts are therefore not a feasible option. The government's response would need to take the form of direct cash payments or some type of in-kind assistance. If there are not sufficient funds, it may even be worth considering reallocating resources by taxing higher-income individuals. Could this be conceived as an increase in income tax through a rise in the progressivity of the tax system? Naturally, there may be opposition to a policy aimed at supporting low-income individuals. From an economic perspective, was the rhetoric of "difficult price control measures" perhaps a pretext for opposing assistance targeted solely at the low-income population? While such considerations may not belong to the discipline of economics itself, in the study of economic policy, the rhetoric employed to justify or oppose policies becomes a subject of analysis.