The minimum wage was first established in the late 1930s, and was controversial. The nation was in the middle of a depression, and critics of the legislation establishing a federal minimum wage argued that it would set the nation back in its path to economic recovery because it would increase labor costs too much. The economy did eventually recover, but critics remain convinced that the minimum wage’s contribution to inflation is a drag on the overall economy, and that the free market should be allowed to determine how much workers are paid.
What is inflation, anyway?
Inflation is an increase in the price level of goods and services in an economy over months, years or decades. As the price level increases, the amount of goods or services a single unit of currency, i.e. dollars, pounds, euros, can buy decreases, representing a deterioration in the purchasing power of that unit of currency. In general, inflation is measured by a general price index, such as the consumer price index, which tracks the costs of goods and services generally needed by everyone.
Inflation can have a number of impacts on the economy, some good and some bad. Some of the positive impacts of inflation are that it can mitigate the severity of economic recessions and it can also provide some debt relief in cutting the true cost of debt. The negative impacts include volatility in the value of money, which can lead to economic instability, discouragement of saving and investment and scarcity of goods if inflation introduces enough unpredictability into the market to encourage hoarding by consumers.
Labor costs can be a key contributing factor to inflation. By increasing the amount it costs in labor to produce a good or a service, the employer may raise his or her prices to offset his loss, passing the increased costs along to the consumer. Inflating the price will make the buying power of the U.S. dollar decrease.
If the employer cannot pass along the cost of the labor increase to the consumer because of competitive pressure or other factors, that employer will take a loss in his or her profits, which may impact the employer’s ability to purchase new equipment, hire more employees and otherwise expand his or her business.
The common consensus
Today, most economists tend to agree that increases in the federal minimum wage have some impact on inflation, but that the extent of that impact is debatable.
The commonly accepted argument tends to be that labor costs are just one of many factors that can contribute to inflation, such as materials cost, service and utilities costs and tax burdens. Because minimum wage workers make up only a small portion of the overall economy, boosts in their wages, especially small ones, are likely to have a very small impact on the economy as a whole, where as other factors that touch all aspects of the economy, such as a tax hike, are likely to have a bigger impact on pushing inflation upward. Another key argument against the idea that increasing the minimum wage causes rises in inflation is the fact that the vast majority of minimum wage workers are not full-time workers. Because most minimum wage earners are only part-time, the impact of an increase in the federal minimum wage is likely to be marginal.
During an economic downturn, it’s more likely that increases in labor costs are more likely to contribute to inflation, as these costs are likely to take a bigger chunk out of employers’ budgets when business is bad. However, competitive pressure and the scarcity of consumers during a recession or depression may have a mitigating effect on labor’s impact on prices, as businesses will keep prices low to appeal to the fewer customers available. Evidence of this can be seen in the current recession, where the minimum wage has risen drastically, but other pressures have kept the rate of inflation low.
Some economists argue that indexing the minimum wage to the consumer price index, so the minimum wage rises with prices and in a more gradual manner than the current system, where the minimum wage rises at the whims of Congress, would have an even smaller impact on inflation. The minimum wage rose by almost two dollars over the past three years after staying stagnant for a decade. If the minimum wage had risen gradually with inflation over this time period, the impact of increases in the minimum wage on inflation would likely have been less than boosting it by large amounts over the past three years has done.
Overall, while it appears that an increase in the minimum wage likely contributes somewhat to inflation, the impact is likely acceptable by most parties in exchange for the benefits it offers lower income workers.