Who Likes High Prices?

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis and the News

Phillips et al. (1937) convincingly argue that the Federal Reserve was seeking to stabilize general prices at an artificially high level during the 1920s. But who was the central bank trying to placate with this policy? As of yet, the Fed had no formal 'price stability' objective.

The everyday consumer certainly does not clamor for higher prices. Always and everywhere, the average person welcomes lower, not higher, prices in order to extend purchasing power and standard of living. And that is what should occur in unhampered markets as improved productivity thru capital investment puts downward pressure on prices.

Who, then, benefits from prices being propped up? Several groups come to mind.

Inefficient and uncompetitive businesses. It is easier to manage operations when selling prices are high. Environments that exert downward pressure on prices require more capacity for innovation and efficiency. When prices are artificially kept high, less entrepreneurial energy is required.

Leveraged entities. Entities carrying lots of leverage dread lower prices. If you've borrowed money to buy or produce balance sheet assets, then declining price environments threaten your solvency. The value of assets declines while debt values remain constant. Equity gets thinner and, if prices decline enough, you're upside down and busted. Banks are classic examples here. In the 1920s, farmers constituted another large group with a powerful lobby.

Bond sellers. Governments and businesses that want to sell debt can sell to non-economic buyers when central banks are in the market buying via their 'open market operations.' Bond sellers can sell their paper at higher prices and at lower coupons than they otherwise could.

The Fed itself. Legitimacy increases for a central bank that it can manipulate market prices. Moreover, central planners that possess the control gene may not be able to restrain themselves from meddling in monetary affairs.

It is likely that various institutional forces were influencing Federal Reserve actions to prop up prices during the 1920s. Those pressures remain with us today.