Does Raising the Minimum Wage Increase Inflation?

In the 2010s, fast-food workers across the United States started asking for a minimum wage of $15 per hour. If their demand is granted, and the federal minimum wage is increased to $15 per hour, a typical minimum-wage worker could earn around $30,000 per year.

There are conflicting views on whether raising the minimum wage increases inflation. Let's take a look at the broad macroeconomics impacts of raising the minimum wage to understand its relationship to prices better.

Key Takeaways

  • Raising the minimum wage has been an issue for decades, with recent pushes to raise the federal minimum wage to $15 per hour.
  • There are conflicting views on whether raising the minimum wage increases inflation. 
  • The central debate revolves around whether raising the minimum wage creates cost-push inflation as companies attempt to recover higher expenses through higher prices.
  • Some economists argue that raising the minimum wage artificially creates imbalances in the labor market and leads to inflation.
  • Other economists note that when minimum wages have been raised historically, inflation did not follow.

Brief History of Minimum Wage

The concept of minimum wage was adopted in 1938 under the Fair Labor Standards Act (FLSA). The purpose of this legislation was to provide fair labor standards in employment regarding wages and maximum workweek hours, and the FLSA has been continually revised throughout history. When approved on October 24, 1938, the FLSA established a Federal minimum wage of $0.25 per hour. The current Federal minimum was established in 2009 is $7.25 for all covered, non-exempt workers though states can establish their minimum wage.

The backdrop of the FLSA has always considered implications for national and local economies. The FLSA was quickly amended in June 1940 after it was discovered there would likely be potential undesirable impacts on the economies of Puerto Rico and the Virgin Islands.

More recently, the 2007 FLSA amendments increased phased minimum wage increases in the Commonwealth of the Northern Mariana Islands and American Samoa. Although the goal is to bring these minimum wages equal to the general federal minimum wage, careful legislation was enacted to perform this economic change over years.

Broad Economic Impact of Minimum Wage

There are many factors to consider when gauging how minimum wage legislation impacts a nation's economy. Before we look specifically at inflation, it's important to understand other ways minimum wage impacts an economy—as these impacts may have residual impacts on prices as well.

The minimum wage has a psychological impact on workers and their labor capacity. A 1990 study published by Oxford University Press written by George Akerlof and Janet Yellen find that worker effort and morale are positively correlated to wage satisfaction. When workers are satisfied with their wages, they work harder. Though the full implications of harder workers can't be fully measured across an entire nation's economy, there are non-financial implications of a minimum wage.

A minimum wage can also have long-term, residual impacts that may not be immediately measurable as inflation. For example, a 2012 study by Arindrajit Dube, William T. Lester, and Michael Reich analyzed how the U.S. minimum wage impacts labor flow, job transitions, and general market friction. They found that raising the minimum wage can result in fewer job-to-job transitions.

Due to the high cost of hiring a new employee including recruiting talent, onboarding new workers, and training new staff, a company may residually need to raise its prices to compensate for the additional expenses. In addition, staff shortages due to turnover may lead to a decrease in production, manufacturing, and general product supply (thereby further increasing the price of the product).

Arguments For and Against

Because of the broad impacts of minimum wage, it is not always straightforward what impact it has on inflation. There are arguments on both sides regarding whether or not minimum wage escalates inflation or not.

Position: Minimum Wage Increases Inflation

A strong cohort of economists believe a national minimum wage increases inflation. Here are some arguments to support the position.

Economists argue that too high of a government-mandated minimum wage creates an artificial floor in the labor market, which can cause distortions and inefficiencies. Their rationale is that, in a free labor market, somebody may be willing to work a job for $10 per hour. However, since the government mandates an hourly pay of at least $15, a worker cannot competitively bid lower for the job and will drive higher product costs.

With regard to inflation, so-called wage push inflation is the result of a general rise in wages. According to this hypothesis, in order to maintain corporate profits after an increase in wages, employers must increase the prices they charge for the goods and services they provide.

The overall increased cost of goods and services has a circular effect on the wage increase; eventually, as goods and services in the market overall increase, higher wages will be needed to compensate for the increased prices of consumer goods.

Some believe a higher minimum wage would eliminate small businesses unable to meet the financial obligations of higher costs. small businesses. As a result, the closure of a number of small businesses could reduce the product availability and supply; with no change in product demand, consumer prices may residually increase.

The increased risk of business closure is a concern when comparing companies that leverage foreign imports or international labor. With rising minimum wage, companies may feel more motivated to seek cost-cutting measures such as exploring cheaper wage options. This may adversely impact product quality or product availability and may have further implications on pricing.

After a brief decrease in the month prior, May 2022 Consumer Price Index measurements demonstrated year-over-year inflation had increased to 8.6%.

Position: Minimum Wage Does Not Increase Inflation

While arguments for wage-push inflation exist, the empirical evidence to back these arguments up is not always strong. Historically, minimum wage increases have had only a very weak association with inflationary pressures on prices in an economy.

For example, in 2016, researchers from the W.E. Upjohn Institute for Employment Research examined the effect of prices on minimum wage increases in various states in the U.S. from 1978 through 2015. They found that "wage-price elasticities are notably lower than reported in previous work: we find prices grow by 0.36 percent for every 10 percent increase in the minimum wage." Moreover, increases in prices following minimum wage hikes generally have occurred in the month the minimum wage hike is implemented, and not in the months before or the months after.

There may be a few reasons for this. A higher minimum wage can be offset by heightened productivity by workers or trimming down a company’s manpower. For example, a 2010 study by Laura Bucila and Curtis J. Simon found higher minimum wage reduces the rate of absenteeism and number of non-sick work absences.

Employers, forced to pay more in wages, may also end up hiring fewer workers, which can lead to higher unemployment because those workers who were perhaps willing to work for lower wages are not hired. As unemployment rises and discretionary spending capacity decreases, the economic theory is inflation would decrease as there is less demand for products.

How Does Minimum Wage Affect Inflation?

There are many complex aspects to analyzing the relationship between minimum wage and inflation. Historical data supports the stance that a minimum wage has had a minimal impact on how companies price their goods and does not materially cause inflation. Some companies may find there may be ancillary or downstream impacts of raising wages due to their operating location, industry, or composition of labor.

Is Minimum Wage Tied to Inflation?

No, the federal minimum wage is not tethered to inflation. The annual minimum wage set by the federal government does not chang each year in response to change in prices.

Will Wages Go Up With Inflation?

Wages currently do not necessarily increase with inflation. The Federal minimum wage is not pegged to inflation, and companies have full discretion on whether to increase salaries above the minimum wage. Whether or not wages should increase with inflation is a highly philosophical question with deep economic impacts. To many, raising wages during inflationary periods seems like the right thing to do, but there may be negative economic consequences (like creating a spiraling situation of inflation).

Why Shouldn't We Raise Minimum Wage?

There are several arguments against a minimum wage (or raising a minimum wage). Some expect a raising the minimum wage to create operating pressure on companies and require a business to increase the prices of their goods. Others believe increasing the minimum wage will cause companies to hire less workers, leaving individuals unemployed and causing broader detrimental impacts to the economy.

How Does Minimum Wage Impact the Economy?

There's no straightforward, fully agreed-upon way that minimum wage impacts the economy. Some believe a minimum wage excludes workers from an economy as a company may not have enough resources to hire additional labor. Others believe a minimum wage increases worker productivity and further benefits a company.

Many believe cost-push inflation is caused due to elevated input prices. However, there is sufficient historical data to demonstrate that a minimum wage has a minimal impact on how goods are priced.

The Bottom Line

The relationship between minimum wage and inflation is incredibly complex. Some believe raising the floor of what workers can earn will create pressure on prices and have adverse impacts on the economy. However, historical data seems to support the notion that raising it to keep pace with inflation would only have a minimal effect. In addition, numerous studies demonstrate the positive impact minimum wage can have on workers, potentially causing further positive economic impacts.

Article Sources
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  3. George A. Akerlof and Janet L. Yellen. "The Fair Wage-Effort Hypothesis and Unemployment." The Quarterly Journal of Economics, Vol. 105, No. 2, 1990, pp. 255-283.

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