Does the Minimum Wage Cause Inflation or Unemployment

Economic growth is pushing towards 10 years as of this writing. The 2008-09 recession was deep and slow in recovery. Fewer jobs at lower wages coupled with the long time frame unemployed people had to wait to even get a job at any wage caused tempers to flare. The minimum wage was raised in 2007, 2008 and 2009 to the current federal rate we have today.

Jobs available as the recession eased were not of the same quality as jobs lost. More workers were among the working poor, earning minimum wage or close to it. Eventually a vocal crowd demanded a $15 an hour minimum wage. It all sounded good. And fair to workers making less. Business owners also made powerful points. In the end nothing of consequence came of the movement. The expanding economy lifted wages, nullifying the demands of the activists. Better jobs with higher wages started appearing, too. People used to a higher income had greater opportunity to explore a pay increase at a new employer if their current employer refused..

The issues never went away; they’re just hibernating until the next opportune moment. Many myths cropped up during the debate. Does a modestly higher minimum wage cost jobs? Does it increase automation, eliminating the job completely? Do worker deserve a fair wage? A higher wage than $10 or so?

I did some research to see if the minimum wage causes inflation, another of the complaints against increasing the minimum wage. Of course, most people agree workers should be paid fairly. We all want to earn more for our efforts. Even business owners understand employees need a living wage.

We will explore some of these myths and how they affect your personal finance decisions. As with most issues, the answers aren’t as clear as activists claim; businesses, either. The debate gets steeped in politics when economic matters are considered. This article will explain the truth behind the myths and what government and you can do about it.

First we address the myths.

Myth #1: The Minimum Wage would be $22.50 an Hour if it kept Up With Inflation

At first I accepted this claim at face value. After thinking about it for a while I began to doubt the claim. Protesters claimed the minimum wage would be somewhere in the neighborhood of $22.50 an hour if the minimum wage had kept up with inflation from a certain date. Extraordinary claims require extraordinary proof! Fortunately we have actual data to determine if the minimum wage now is lower than in the past, adjusting for inflation.

I will do the heavy lifting for you. I’ve included links if you wish to dig deeper into how the minimum wage has fared against inflation. We will test this claim by looking back to 2009, 1990 (a date protesters sometimes used in their claim), 1978 (another date used by protesters) and all the way back to the beginning on October 24^th, 1938 when the first federal minimum wage was instituted in the U.S.

Disclaimer: Several states have their own higher minimum wage. We are discussing the federal minimum wage only. Minimum wage data was used from the U.S Department of Labor and the Consumer Price Index-U (all urban areas) was used in calculating the inflation adjusted minimum wage.  We will not address salaried workers, restaurant workers or individuals under age 20 first starting a job, all of which have a different minimum wage.

Adjusted Minimum Wage from 2009: The current federal minimum wage is $7.25 an hour. There are other rates based on age and occupation. To keep this post brief I will focus on 1938 Act until 1978 where I use the all nonexempt workers rate.

The federal minimum wage was last increased, effective July 24^th, 2009. The CPI index stood at 215.351 in July of 2009. The latest reading for June 2018 is 251.989. The index has increased 36.638 points since the last minimum wage increase, or about 17%. If the minimum wage were indexed to inflation the minimum wage would now stand at $8.48 per hour. My guess is that in the near future the federal minimum wage will be increased to $8.50 – $9.00 per hour. This would accurately reflect the increase in average consumer prices over the time period.

So, the argument the minimum wage should be $22.50 doesn’t work calculating from 2009.

Adjusted Minimum Wage from 1990: The minimum wage was increased on April 1^st, 1990 to $3.80 per hour. The CPI was 128.9. The CPI increased 123.089 points since April 1990, or a 95.49% increase. Adding 95.49% to the then minimum wage of $3.80 gives us $7.43 an hour, pretty close to the current minimum wage. Maybe we need to go back further.

Adjusted Minimum Wage from 1978: The minimum wage was increased at the beginning of 1978 to $2.65 an hour. The CPI stood at 62.5 in January, 1978. This is an increase of 189.489 points or 303%. Increase the then current minimum wage of $2.65 by 303% and we get $8.03 an hour. Hmmm. Maybe we need to go back all the way to the beginning.

Adjusted Minimum Wage from 1938: The first federal minimum wage in the U.S. began October 24, 1938 at $.25. Yes, that is 25 cents an hour. The next year they raised it to $.30 an hour. We will still use that original minimum wage starting point to determine if the minimum wage is worse today than it was in the past.

The CPI stood at 14 in October of 1938. The index has climbed an additional 237.989 points since. The CPI is a whopping 18 times what it was in October 1938! This means the original minimum wage, adjusted for inflation was {drum roll}: $4.50 an hour.

Oh-oh. The claim minimum wage should be over $20 an hour now doesn’t hold up. But this isn’t the only myth batted around.

Myth #2: Increasing the Minimum Wage Causes Job Loss

This scare tactic crops up every time a minimum wage increase is mentioned. As you can see from Myth #1 above, the minimum wage has been a minimum burden on business since the beginning. Since 1938 technology and productivity have increased massively. If business can’t keep up with the barely minimal minimum wage increasing at somewhere in the vicinity of the inflation rate, business needs to do something else.

Does increasing the minimum wage cost jobs? Well, business tells us if we increase the minimum wage business will automate the jobs away, eliminating the entire labor cost. McDonald’s and Wal-Mart gave us this song and dance. For the record, in the last 10 years Wal-Mart has replaced a large percentage of cashiers, requiring customers to check themselves out. McDonald’s is replacing workers fast with automated order taking (similar to Wal-Mart’s check-out kiosks) and cooking robots. The minimum wage remained static for a decade and automation happened anyway! The minimum wage had little to no bearing on that corporate decision; finding qualified workers willing to work at minimal wages was.

Of course, the economic professor in me says that when prices increase, demand drops. It’s Macro Economics 201 (or is it 202, it’s been a long time since my college course). A higher minimum wage does reduce jobs minimally! Wages tracking inflation is NOT a REAL wage increase. So what is business talking about? They’re talking about maximizing profits on the back of minimum wage workers. I get it, but it’s still a myth jobs are lost when wages increase. Higher wages increase inflation, not demand for labor. Demand for labor is based on economic conditions.

Myth #3: Workers Paid Minimum Wage Aren’t Getting a Working Wage

Even business owners agree a person should be paid a reasonable wage for their labor. The question revolves around “working wage”. Are workers paid near minimum or minimum wage paid a working wage? Well, I’ll be the first to admit $7.25 an hour isn’t a lot and lacks the motivational ability to move the crowds. For young people starting out its fine, but even then, what’s the motivation to perform maximum when the pay is minimum? Just asking.

But the minimum wage isn’t the only source of income for these workers. The tax code provides an Earned Income Credit for workers with low income. The EIC is a refundable credit and tax-free to the recipient. Many states also add to the federal Earned Income Credit.

All this combined is still hard time. Full-time (40 hours per week) at $7.25 an hour is only $290 per week. Ouch! Payroll taxes take 7.65% off the top. Good thing there is an Earned Income Credit! This equates to $15,080 a year without a pay increase in site.

I never said it was pretty. Then again, the minimum wage was never called a working wage (unless they said it back in 1938).

The Federal Reserve’s Money Printing Problem

Now we can put some of this knowledge to work.

Interest rates peaked well into the double digits in the early 1980’s. Rates have steadily declines, with only temporary increases, since. Anyone under age 35 has never lived through a serious increase in inflation and/or interest rates! This is nearly two generations who have never experienced how bad, bad can get.

From the early 1980s until the mid-2000s the Federal Reserve was able to nudge the economy along by lowering interest rates through a variety of lending facilities. The Great Recession which started in 2008 brought interest rates to zero and the economy still only limped along. The solution the Fed settled on was Quantitative Easing where the Fed bought up massive quantities of Treasuries and mortgage securities. The buying was in the trillions! The Fed balance sheet swelled from around $800 billion to the $4.5 trillion neighborhood. And they couldn’t get a pulse from inflation no matter how many smelling salts were used.

I’ve argued in the past on the reasons why all the money printing around the world didn’t cause runaway inflation. In short, much of the newly created money never entered the economy. Money center banks and central banks around the world stuffed their vaults with digital cash. It made the books look better so banks could lend if necessary. The result? The economy limped slowly out of the Great Recession in fits and starts, but finally grew to record length proportions. It’s been a long recovery and new heights have been reached.

But interest rates are still very low. If another recession arrives (some might say we are due), the Fed will not have much room to maneuver. If they try the old “print more money” strategy used last time it could compound the issues.

This is where the Fed and elected officials need to review the data for additional options. And I have a powerful one.

Getting Inflation (and Economic Growth) the Federal Reserve Wants without Printing More Money

The chart you see in this section I put together with data from the U.S. Department of Labor, the Bureau of Labor and Statistics and InflationData.com. When I asked the question: Does increasing the minimum wage cause inflation? I had to dig further than the available charts. It was necessary to determine if there was a correlation between inflation and the minimum wage. If there is a correlation the monetary and fiscal implications are significant. It also effects personal finance decisions in a serious way.

This exercise is more than a macro-economic research project. If a correlation exists, the Federal Reserve and Congress will want to act appropriately in the future. It also means everything we know about the rate of the minimum wage is wrong!

If you examine the chart closely there does appear to be a modest correlation between a minimum wage increase and the rate of inflation. However, the correlation isn’t clear. In the 1970’s, the increasing minimum wage supported inflation rather than lead to inflation. In the Great Recession it seems like the minimum wage increase had no effect at all.

In the same way astrophysicists glean the data for a slight wobble in a star to determine if a planet orbits said star, I had to push away all the noise and look for a wobble in the inflation data. Productivity, Fed policy and economic conditions provided plenty of background noise to distract for the data. But I did find a wobble.

The minimum wage was instituted during the tail end of the Great Depression. Adjusted for inflation, the first federal minimum wage was around $4.50, but a year later it increased to an inflation adjusted $5.40 an hour. This new minimum wage was started in what many call the second Great Depression. From 1929 to 1932 the economy collapsed at a rapid pace. Recovery was incomplete by 1937 when the Fed started raising interest rates causing the economy to once again slow and the stock market to decline hard.

Then we get a new minimum wage in 1938 and prices start to climb. The data used in the chart only includes average inflation for each year. The data detail (found using the link above from InflationData.com) reveals a more immediate response. The chart makes it look like the minimum wage could have caused some inflation, but in reality World War II had a lot to do with the price levels at the time.

Deflation was a serious issue early in the Great Recession. Prices were actually declining! Inflation is bad, but deflation makes it incredibly hard to spur economic growth since waiting to purchase a good or service is likely to be cheaper tomorrow.

The Fed had its hands full with declining prices, high unemployment and the banking industry in ruins. Interest rates dropped to zero percent. Some countries experimented with negative interest rates to no avail. The economy was growing at an anemic pace (still declining in some countries) with virtually no inflation. Creating massive quantities of new money didn’t do the trick hoped for. It in the end did save the day, but at what cost. The next time we need help from monetary policy we are out of bullets. Do we keep creating more money? How far do we push the economic system out of balance? What if we can’t kick the can further down the road?

The wobble is in the data! Increasing the minimum wage does cause mild inflation very quickly. Unfortunately, the lift is short lived. But it is another planning tool for the government and a key point you, kind readers, need to understand.

The minimum wage was increased during the Great Recession and it kept prices stable. Only after the wage increase subsided into the past did prices start to fall. The printing press was all we had. Even in the second leg of the Great Depression the new minimum wage didn’t harm the economy. Few jobs, if any, were lost. Prices started to increase, encouraging demand and production, creating even more jobs.

Armed with this information the government should avoid raising the minimum wage during economic “good times”. Rather, when business says they can least afford it is when it needs to be done. Inflation is sparked by demand. Since the minimum wage is increased after long periods of flat lining, the increase tends to be a larger than average percentage. People earning minimum wage spend all their paycheck and quickly. The added demand encourages more production and helps reduce deflationary pressures.

How does this affect you? Well, the best time to increase the minimum wage is when the most people need it. Myth #2 is clear; increasing the minimum wage reduces very few jobs. Business can afford an increased minimum wage during an economic slowdown. It’s been done before without serious disruption. It also lays the foundation to renewed economic growth and increased business profits. It’s in business’s best interest to raise the minimum wage as the economy begins to cool. This encourages more demand while spurring mild price inflation; a catalyst encouraging continued growth.

You can use this information in your personal finance decisions as well. An increase in the minimum wage will increase business activity, a good sign for investors. If everyone digs in their heels and refuses to increase the minimum wage when this data suggests its value, get ready for a long economic war with no winner until somebody blinks.

 

 

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