Does Increasing Minimum Wage Increase Inflation?

Many wonder if an increase in the federal minimum wage will also increase inflation.

Math tells us this is true but it depends…

There are many factors to have into account that when put together, point to a none conclusive veredict.

What is Inflation?

Inflation is the purchase power decrease of a designated currency over time.

It occurs whenever the price of goods and services increases, making the currency lose a percentage of its buying power over the years.

Inflation can be better understood by comparing the current price of goods and services to previous years.

Average Cost: Gallon of Gas

Why has the Price of Gas Increased so Much Over Time?

The overall rise in prices reflects economic growth, the more demand there is, the higher the rate of inflation.

As a general trend in the gasoline world, crude oil supply remains steady over time while demand keeps increasing exponentially, this catapults prices upward.

According to hedgescompany, there are about 25 million new drivers in the US alone from 2009 to the present date.

This means more gasoline is used now than a few years back.

As long as the economy keeps thriving and the world developing, gas prices will keep rising due to the law of supply and demand.

What Drives Inflation?

If you ever thought of inflation then the questions “why don’t the prices just stay the same every year?” or “why don’t we just print more money?” have certainly come to mind.

The world is dynamic, nothing ever stays unchanged forever, people grow old, they move, have children, marry, divorce, and… Prices are not different. They slide along the economy’s ups and downs.

Printing more money without a strategic reason would only produce hyperinflation and as result, an economic collapse.

A great example of this is Zimbabwe’s 2008 hyperinflation crisis, the government started printing more money in response to national debt, economic output and exports were on the low and on top of the fragile economy, corruption took place.

This caused a sinking spiral of hyperinflation, prices of goods and services suffered an inflation daily rate of 98%, costing twice as much each following day.

Eventually, the recession caused the Zimbabwean dollar to be replaced by US dollars.

Understanding How Inflation Happens

Inflation comes from two main sources: Demand-pull and Cost-push.

Demand-pull inflation

The common source of higher prices, it happens when consumer demand is so high that supply sources can’t keep up, it may happen due to raw material scarcity, not enough workers, or not enough time to build a steady supply.

When this scenario takes place, sellers typically raise prices in order to lower demand and avoid product shortage, this often creates angry customers but at the same time regulates the balance between supply and demand.

Big brands take advantage of consumers to create demand-pull inflation for specific goods or services

Ever felt that a product’s price is way above what it should? You’re probably right, chances are that product is coming from a popular brand too.

Often times the cost of production does not justify a product’s market price, well-established brands have demand on their side, they market their products to create a sense of premium exclusivity and grab the opportunity to drive up the prices.

This is why consumers opt to pay a much higher price for a MacBook instead of buying a lower-priced laptop with similar characteristics.

This is demand-pull inflation in a nutshell, it starts from the customer side.

Cost-Push Inflation

Originates from the supplier side.

When demand stays unaltered but costs of production increase due to pricier raw materials, costs of wages, production inventory or any other reason, this type of inflation takes place.

Have a look at this simplified supply chain:

Raw material is collected and suffers transformations through different stages before reaching the consumer in its final form.

Following the example, let’s say the raw material’s mining cost increases from 2$ to 4$.

As consequence, a chain reaction of cost-push inflation follows, pushing the added costs towards the final consumer.

Other causes of cost-push inflation worth mentioning are natural disasters and government regulations or changes in laws.

Would Federal Minimum Wage Increase Also Increase Inflation?

It’s debatable.

In Theory

An increase in the federal minimum wage ($7.25 per hour) would affect costs of production nationwide, companies would need to charge more for their services/products to sustain the extra costs.

There’s also the problem of more qualified workers in a firm earning just above co-workers on minimum wage, it’s in a company’s best interest to maintain employee’s wage differentials as a reward for qualification, this would further increase the costs for the firm.

Another inflation-inducing factor would be demand, extra income translates into more purchase power which leads to more spending, therefore, creating a degree of demand-pull inflation.

In Reality

Unless an astronomical increase would take place, the inflationary effect would most likely be muffled.

Different states have different minimum wage numbers

The federal minimum wage is established as a minimum payment, many states pay well above $7.25 per hour.

This year, many states also increased the minimum wage.

Only people earning the federal minimum wage or below would be affected by an increased value and those account for a small percentage of the US population.

Well-established firms also have the luxury of absorbing wage increase costs by decreasing the gross profit margin.

Overall, a careful and thoughtful minimum wage increase wouldn’t make a significant scar in the economy.

Why Minimum Wage Didn’t Keep up With Inflation?

The way the economy is currently shaped is the reason why, those at the top take home the largest piece of pie and the average worker takes home the crumbs, over-rewarded professionals with sky-high wages have been draining the economy for the longest time now.

Workers compensation hasn’t kept up with the productivity index since the 70’s, if the minimum wage had kept up with inflation, it would be over 24$ per hour now.

CEO wages increased 1000% over the last 40 years while average workers saw an 11.9% increase during the same time frame, narrowing the gap between CEOs and average workers would be a great foundation to safely raise minimum wages.

Companies See Workers as Expenses Rather Than Growing Investments

Often more than not, companies are sitting on piles of cash and aim profits solely towards their shareholders, investing in their share prices instead of raising salaries, most companies see workers as expendable and do basically nothing to hold them.

The source of the problem is not the economy, it’s poor management that favors the company’s interests and widens the gap between administration and lower-level employees.

How to Beat Inflation?

Investing and reinvesting over and over.

Letting your money sit still in the bank is not the best approach to retire comfortably due to inflation, a basic savings account is a good way to save up in a short span of time and grants easy access to your savings but it doesn’t beat inflation.

If you’re afraid of risking your money in the stock market, one of the most reliable ways to beat inflation is to contribute to a 401(K) Plan or a similar retirement account.

However, if you just stick to retirement accounts, you’re missing out on potentially life-changing investments.

It’s a known fact that stock market investments are risky, but not investing is an even bigger risk often acknowledged by the time it’s too late to react.