Newsflash: Minimum Wage Hikes Can Contribute to Inflation

As inflation has reached historical levels, lawmakers and analysts are grappling with the causes, including the shocks from the pandemic, both related to government-imposed restrictions and shifts in consumer demand.

This week on Twitter, one New York Times writer said the recent media headlines concerned about inflation are just “rich people” blaming policies like the $15 minimum wage. Instead of being justifiably concerned about the rapidly rising prices of common products, she argued the recent coverage is simply “hysterics,” also insinuating that inflation is actually beneficial to lower income people because “inflation favors debtors, and that’s what the hubbub is about…not milk prices.”

Unfortunately on both accounts, these arguments are incorrect.

Historical experience with minimum wage hikes show they do in fact cause prices to rise, which in turn most directly affects lower to middle income people who spend a larger proportion of their earnings on goods affected by inflation such as groceries.

A report by Heritage Foundation fellow James Sherk documents the snowball effect between minimum wage hikes, such as the $15 per hour already in several states and localities and proposed at the federal level this year, and resulting price increases. For example, a $15 federal minimum wage translates to a 107% increase of the current $7.25 per hour federal wage. When governments mandate steep minimum wage hikes, employers must alter their business model to account for the rising wage bill. In many cases, this requires businesses to raise prices that consumers pay to adapt to the greater cost of delivering their goods or services. Sherk argues this harms minimum wage earners and lower-income consumers the most, since now the prices of items they buy have increased too, reducing the purchasing power of their newly raised wages.

One review of the existing minimum wage literature containing predominantly United States data on price effects concludes that a 10 percent minimum wage increase raises prices by up to 0.3 percent.

One of the studies reviewed from the American Enterprise Institute found in the southern United States where living costs and wages were significantly lower, the same price hike could cause price increases up to 2.7%. More recent research also confirms the inflationary effects of rising minimum wages more significantly impact employers of minimum wage earners. For example, a Federal Reserve Bank of Chicago and U.S. Department of Agriculture study found the price increase effect of a minimum wage hike was more than doubled in fast-food restaurants, and even higher in lower-wage areas.

In addition, a Stanford University economist studied the distribution of price hike impacts by income level, and found that while “minimum wage workers live in families across the income distribution,” increasing the minimum wage drives the largest price increases for the poorest 20% of families.

This review of past research clearly demonstrates that minimum wages cause employers to raise prices to offset some of the increased wage bill. But this too comes at a cost – employers must be careful not to raise prices too much, triggering customer demand that is sensitive to price changes. Employers are unable to raise prices if they assess doing so will negatively affect demand and result in lower revenues, which will also not cover the increase in employee wages. If this occurs, employers are forced to adjust costs in other ways – like cutting other employee benefits, reducing scheduled hours for their employees, or laying employees off altogether.

Sherk argues the price hike effect of raising minimum wages combines with significant employment loss effects, meaning minimum wage earners are more likely to lose their jobs or experience reduced hours all while their cost of living increases. As a result, he maintains that raising minimum wages is an ineffective way to deliver benefits to lower income employees, given their inflationary and job-killing effects.