What You Need To Understand About the Relationship Between Inflation and a Rising Minimum Wage

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In the 2010s, an uprising by underpaid fast-food workers led to a national movement for a $15 minimum wage. Today, that movement has led to a push by mainstream Democrats to make that dream a reality by 2025 — but thanks to the incessant grinding of inflation, $15 won’t be worth $15 in four years.

The Economy and Your Money: All You Need To KnowRead More: Inflation’s Ups and Downs: How It Impacts Your Wallet

Inflation impacts the minimum wage and the minimum wage impacts inflation. Here’s what you need to know. 

Over Time, Inflation Puts the ‘Minimum’ in Minimum Wage

Inflation gives every worker in America the opposite of a raise every minute of every day by reducing the purchasing power of the dollar over time. The minimum wage hasn’t changed since it was adjusted to its current rate of $7.25 an hour in 2009. That’s the longest period of stagnancy since the original minimum wage was set at 25 cents in 1938. 

More Economy Explained: Understanding the Differences Between Inflation, Deflation & Stagflation

Inflation, on the other hand, has been anything but stagnant.

Thanks to inflation, the cost of living grew by 27.3% between 2009 and 2021. Something that cost $7.25 then would cost $9.23 today. Another way to look at it is that the real minimum wage of $7.25 in 2009 dollars has the buying power of just $5.27 in 2021. Needless to say, the minimum wage has not kept pace with inflation — and it never will unless it’s raised annually.

Find Out: Understanding Interest Rates — How They Affect You and the US Market 

A Higher Minimum Wage Would Make Labor — and Everything Else — More Expensive

If a higher minimum wage becomes a reality, higher prices are sure to follow. That’s because the law of cost-push inflation dictates that when “inputs” like raw materials or, in this case, labor get more expensive, businesses are forced to compensate by raising prices. At the same time, millions of wage earners who suddenly received a raise would have more money to spend on products and services, which would cause demand — and therefore prices — to rise.

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Check Out: What Does Cost of Living Include and How Is It Calculated?

Wage-Related Inflation Would Make Money Cheaper To Borrow

According to America magazine, higher inflation caused by an increased minimum wage would be “a good thing.” The publication’s reasoning is that long before the pandemic, both interest rates and the rate of inflation had been stuck at near-zero for almost a decade. This reality causes two economic problems: 

  • Since interest rates can’t fall below zero, the Federal Reserve Board can’t use interest rates to stimulate the economy when rates are too low for too long. 
  • Prolonged zero-inflation is dangerous because, during a recession, ultra-low inflation can quickly turn to deflation, which is when prices fall economy-wide. Deflation is economic kryptonite because when prices fall, consumers put off making purchases under the assumption that prices will continue to drop. Also, deflation increases the real cost of borrowing money, which smothers investment. 

As previously mentioned, an increased minimum wage would cause prices to rise. The publication calls that “a good thing” because the end result is that “real interest rates” — the actual cost of borrowing — would fall, which would spur investment by making it cheaper to borrow money.

Good To Know: How To Tell If the US Economy Is Actually ImprovingImportant: What Do Banks Do With Your Money After You Deposit It? 

Or Maybe a Higher Minimum Wage Wouldn’t Affect Inflation at All

Conventional wisdom says that cost-push inflation would drive prices up in the wake of a minimum wage hike, but not all economists agree. The most notable argument to the contrary came out of the W.E. Upjohn Institute for Employment Research. The institute argues — while conceding that more research is needed to reach a definitive conclusion — that many cities and states have raised their own minimum wages without experiencing a notable rise in inflation beyond the first month of the wage increase. In other words, inflation is certain when the minimum wage rises, but it’s not necessarily permanent.

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This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.

Last updated: Aug. 18, 2021


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