In the 2010s, fast-food workers in the United States started asking for a minimum wage of $15 an hour, or almost double what they were earning. If their demand is granted, a typical McDonald’s employee would end up earning more than $30,000 per year.

There are conflicting views on whether raising the minimum wage increases inflation. Tied to this is the question of what effect a higher minimum wage has on employment because historically, high unemployment goes hand-in-hand with high inflation. While raising the minimum wage would help stimulate the economy due to the increased spending power of workers receiving higher wages, a former CEO of one of the biggest employers in the United States explained that too high of a government-mandated minimum wage would have a deadly effect on employment.

Key Takeaways

  • Raising the minimum wage has been both an social-economic and political issue for decades, with recent pushes to raise the federal minimum wage to $15/hr.
  • Some economists argue that raising the minimum wage artificially creates imbalances in the labor market and leads to inflation.
  • Others, however, note that when minimum wages have been raised, inflation did not follow.
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Does Raising The Minimum Wage Increase Inflation?

The Argument that Minimum Wages Increase Inflation

Raising the minimum wage has been attacked on at least two fronts. First, economists argue that such a minimum creates an artificial floor in the labor market, which can cause distortions and inefficiencies. The rationale is that in a free market for labor, somebody may be willing to work a job for say, $10 per hour but since the government mandates, say, at least $15 per hour, that worker cannot competitive bid lower for the job. The second argument is that employers, forced to pay more in wages, will end up hiring fewer workers, which can actually lead to higher unemployment as those workers (who were perhaps willing to work for lower wages) are unable to be hired.

With regard to inflation, so-called wage push inflation is the result from 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 would not only kill existing jobs but also result in closing a substantial number of small businesses, from 15% to 20%. In theory, raising the minimum wage forces business owners to raise the prices of their goods or services, thereby spurring inflation. In actual practice, however, it is not so simple since 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.

The Argument that Minimum Wages Do Not Increase Inflation

While the arguments for wage-push inflation are appealing, the empirical evidence is not so solid. In fact, looking back at the history of minimum wage increases has only a very weak association with inflationary pressures on prices in an economy.

According to a recent piece of economic research that examined the effect of prices on minimum wage increases in various states in the U.S. from 1978 through 2015, they found that a 10% increase in minimum wage only accounts for around a 0.36% increase in prices. 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. Interestingly, they find that small minimum wage hikes (e.g. on the order of 5-15%) do not lead to higher prices, and they might actually lead to lower 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

So, is raising the minimum wage a good idea for the economy? Suffice it to say, raising the minimum wage to an excessively high rate would exert inflationary pressure on the economy, but increasing it to keep pace with inflation would only have a minimal effect.