UK Economy - Policy Focus - Minimum Wages and Inflation

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?

1. 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
2. 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
3. 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
4. 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.
5. The net impact of a rise in the minimum wage on aggregate demand is likely to be small