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. A related question is: How would an increased minimum wage impact employment levels?

Historically, high unemployment has typically coincided with high inflation. It is possible that raising the minimum wage could help stimulate the economy because of the increased spending power of workers receiving higher wages. It is also possible that too high of a government-mandated minimum wage could negatively impact employment levels.

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. 
  • Some economists argue that raising the minimum wage artificially creates imbalances in the labor market and leads to inflation.
  • Others economists note that when minimum wages have been raised historically, inflation did not follow.

Does Raising The Minimum Wage Increase Inflation?

The Argument that Minimum Wages Increase Inflation

Raising the minimum wage has many critics. First, 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, that worker cannot competitively bid lower for the job.

A second argument is that employers, forced to pay more in wages, will end up hiring fewer workers, which can actually lead to higher unemployment because those workers who were perhaps willing to work for lower wages are not hired.

In June 2021, the U.S. Federal Reserve announced no change in its rate policy and did not signal concerns about rising inflation. A week earlier, the U.S. Bureau of Labor Statistics (BLS) reported that the Consumer Price Index For All Urban Consumers (CPI-U) was up by 5.0% through May 2021, the Index's biggest 12-month surge since the 5.4% increase during the period ending in August 2008.

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.

According to economic analyst Ed Rensi, formerly an executive at McDonald’s, a higher minimum wage could eliminate some existing jobs and may also result in the closure of a substantial number of small businesses.

In theory, raising the minimum wage forces business owners to raise the prices of their goods or services, thereby spurring inflation.

In reality, the relationship between rising wages and inflation is more complex: Wages are only one part of the cost of a product or service paid for by consumers. A higher minimum wage can be offset by heightened productivity by workers or trimming down a company’s manpower.

However, while this may be true in certain service sectors, it is unclear that the effect on wages would generalize to other sectors, especially when faced with competition from foreign exports using cheaper labor.

The Argument That a Higher 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 found that "[Using monthly price series] ...the pass-through effect is entirely concentrated on the month that the minimum wage change goes into effect, and is much smaller than what the canonical literature has found."

Their research examined the effect of prices on minimum wage increases in various states in the U.S. from 1978 through 2015. It was intended to explore the magnitude of the pass-through effect and add to the discussion about how different policies may shape the effect that minimum wage increases have on prices.

Their first main finding was 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.

Based on their research, they also make the claim that a "small" minimum wage hike (between five and 15%) does not lead to higher prices. On the other hand, large minimum wage hikes have clear positive effects on output prices (which can ripple through to higher consumer prices).

The Bottom Line

Is raising the minimum wage a good idea for the economy? It depends on what sources you consult. While some claim that raising the minimum wage to an excessively high rate would exert inflationary pressure on the economy, research shows that increasing it to keep pace with inflation would only have a minimal effect.

Article Sources

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  1. U.S. Bureau of Labor Statistics. "Consumer Price Index - May 2021." Accessed June 16, 2021.

  2. Business Insider. "A $15 minimum wage would cause fast-food chains to raise prices or put workers out of jobs, a former McDonald's CEO said." Accessed July 26, 2021.
  3. W.E. Upjohn Institutue For Employment Research. "The Effects of Increasing the Minimum Wage on Prices: Analyzing the Incidence of Policy Design and Context." Accessed July 26, 2021.

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