UK Economy - Policy Focus - Minimum Wages and Inflation
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Last updated 24 Jun 2021
Here is a short revision video looking at whether a rise in the minimum wage will inevitably lead to an increase in the rate of consumer price inflation.
Chain of reasoning: minimum wages & inflation
- A higher minimum wage will, other factors remaining constant, lead to an increase in labour costs for many businesses. Examples might be labour-intensive firms operating in tourism & hospitality or in the health & social care sector.
- Many businesses will opt to pass on these higher costs by raising prices to their customers. This will lead to a direct increase in the consumer price index
- In this sense, a rise in the minimum wage could cause cost-push inflation
- Other workers, paid just above the minimum wage and whose pay differentials have narrowed, may bargain for a pay rise
- And increased aggregate demand might also cause demand-pull inflation if the economy has a positive output gap
Evaluation: Will a higher minimum wage cause inflation?
- Factors other than labour costs might have fallen – for example an appreciation in a country’s exchange rate makes imports of raw materials & components cheaper
- Higher minimum wages might stimulate labour productivity which then means that unit labour costs may stay relatively constant with little risk of a surge in inflation
- Much depends on the scale of a minimum wage rise (contrast a 2% increase in the pay floor with a 10% jump) and also the percentage of wages in a firm’s total labour costs
- In competitive markets, many firms may be reluctant to pass on higher wage costs in the form of increased consumer prices.They may absorb this through lower profits.
- The net impact of a rise in the minimum wage on aggregate demand is likely to be small