The $15 Minimum Wage and how it will impact the economy. What a tuff and expansive subject. Sure. I’m going to write this assuming no knowledge of economics, but for anyone reading this feel free to skip around as a lot of this would be covered in an introductory economics course.
Inflation From $15 Minimum Wage
First, lets go over what inflation is and how it works. Inflation is the loss of purchasing power over time. We most often measure inflation on an annual basis and like to see it somewhere in the range of 1%-3%. This means that at 3% inflation rate a good that cost $1.00 in 2020 would now cost $1.03 in 2021. The reason this is acceptable is because we assume that the economy as a whole will produce more in order to offset the devaluing of our currency. This is generally the case.
There are two main types of inflation that economists deal with, Cost-push and Demand-pull. Cost push inflation is caused when the prices of production goes up. For example, if you’re a plastic company and the prices of oil goes from $30 a barrel to $40 a barrel you will now face higher production costs. And as such the price of your finished product will likely increase. Demand-pull inflation is inflation caused by the demand for a good increasing faster than the supply can keep up. Increasing wages for workers does contribute to both cost-push and demand-pull inflation. But it is only a single factor, and not the only factor to consider.
What you need to be conscious of is what these types of inflation actually mean in terms of raw production. Cost-push inflation is the byproduct of a decrease in the supply of goods. Demand-pull inflation is the byproduct of an increase in the demand for goods. We will look at how a $15 Minimum Wage might impact or be impacted later on.
Monetary policy is a governments ability to expand or constrict the supply of money in the economy. The central bank is how the US carries out this type of policy through adjusting interest rates, selling debt and purchasing assets, and printing currency. All of these are sources of demand pull inflation. Monetary policy is focused on a countries money supply. There are lots of different ways to measure money supply.
Depending on if you want to just look at how much money the central banks has or if you want to include investments. The ones we’re going to focus on is M2. M2 includes all the physical currency of a nation, deposits at consumer banks, and some forms of investment such as savings accounts, small time deposits, and money market accounts. If we factor in foreign money market and institutional money market funds we get MZM which is essentially all of the liquid money available to a nations economy.
Raising the Minimum Wage to $15
Now that we understand the terms lets apply a bit of context. We will see why raising the minimum wage won’t cause an inflationary spiral. From December 2019 to December 2020 M2 expanded from 15 trillion dollars to 19 trillion dollars. The reason why so much money was able to be injected into the economy without causing an inflationary spiral is because it doesn’t get printed out of thin air. It comes from the sale of treasury bonds, essentially an IOU that the government will eventually pay you back. The government is only able to sell these IOUs because someone, somewhere, is willing to buy them, most often investment banks. This allows us to spread out the inflationary impact of this debt by managing it through the interest rate.
The interest rate is essentially the rate at which the federal reserve loans money to investment banks. Consumers mostly interact with this value when they want to purchase a car or house, but investors and business owners deal with it all the time. $15 Minimum Wage does not necessarily play a role. Outside of your personal credit, this is the most influential factor in what type of interest rate you can get. By raising interest rates the fed can earn back the money it needs to pay back debts. This call contractionary monetary policy because it reduces businesses access to money in the form of debt.
Big Business Debt
The issues with adjusting interest rates is that it has a very large impact on demand pull inflation. When interest rates a low businesses have easy access to larger amount of money. This generally lowers unemployment as firms can afford to borrow money for more equipment and workers. They don’t need to make as large a profit to pay back the loan. This also generates inflation. As businesses spend at a much larger scale than consumers and will suddenly have access to significantly more money. Big business runs on debt, so aside from printing money, lower interest rates are one of the biggest factors in demand-pull inflation.
Looking at all of this we now have context for interest and debt based inflation, so let’s examine how a pay raise will impact demand-pull inflation. There are currently about 90 million Americans working for under $15/hour. Let’s assume that all of these workers are making federal minimum wage (they’re not). At $7.25/hour working 40 hours a week every week all year you’re looking at about 1.2 trillion dollars worth of annual wages increasing to about 2.4 trillion dollars worth of annual wages. This expands the M2 money supply by about 600 billion dollars, or about 30% of what it increased by in 2020 alone. This is simply not the type of demand-pull force that people think it is. So what about cost-pull? Does a $15 minimum wage hurt or help?
In the cost-pull sector you will likely see some genuine inflationary forces, but not to the degree people expect. Goods will not all increase in price to offset labor costs is due to something called price elasticity. Price elasticity measures how sensitive consumers are to a change in price for a given good. A good is prices inelastic when consumer demand doesn’t change much as the prices goes up or down.
Something like insulin is price inelastic, because as long as consumers have the money to pay for it, they will. A good is considered price elastic if it is more sensitive to a change in price. You likely won’t purchase a Big Mac if the price went up to $10/burger. Inelastic goods will pass on their increased costs to the consumer. This will cause a bit of inflation as these goods will become a bit more expensive. But the bulk of goods that we purchase are more elastic.
Producers generally try to keep labor costs between 20% to 35% of their revenue, so we will see a small jump in the price of inelastic goods, but this is ultimately insignificant in comparison to the expansion in M2 that we saw earlier. In addition, think back to the fundamentals of cost-push inflation. Higher paid workers are more productive, and automation has resulted in decades of increased output with few increases in wages to match it. While the total production costs will go up, this money ends up back in the hands of domestic consumers/workers and not in the hands of foreign suppliers. This increase in consumer spending allows firms to operate on lower margin, offsetting the increased costs a bit. In the aggregate, it means a small increase in prices for consumers for a larger and long awaited increase in purchasing power.
$15 Minimum Wage Considerations
There are a few things to consider before we all cheer for a $15/hour minimum wage. When you implement it matters. Being able to raise or lower interest rates to either limit inflation or provide firms with the money needed to pay for their more expensive workers is important. Ideally you want a healthy economy before you start to change the minimum wage. There is also a legitimate argument around the urban rural divide. $15/hour honestly is very high for many rural communities.
Local small businesses might have a hard time adjusting to these higher labor costs, especially due to their poor access to credit. This allows large firms like Walmart to more effectively drive them out of business. Exceptions or a lower wage like $12/hour would make more sense for these communities, but $7.25 is absolutely unreasonable. I hope this helps people understand the complexities of managing inflation rates and allows them to help alleviate people’s anxiety about a $15 Minimum Wage .