The Corner

Another Minimum-Wage Fallacy

Proponents of increasing the minimum wage hold two contradictory views on the subject. First, they say that increasing the minimum wage will increase the size of the economy. President Obama recently claimed that increasing the minimum wage from $7.25 per hour to $10.10 per hour would increase GDP by $32.6 billion and would create 140,000 jobs. According to Macroeconomics 101, leaving aside its effects on employment, an increase in wages will increase consumption, which will increase GDP. 

The second claim is that increasing the minimum wage will have no effect on inflation. Jeannette Wicks-Lim, an economist with UMass Amherst, for example, argues, “The potential impact of minimum wage hikes on the overall price level is simply too small to have any appreciable impact on inflation.” Basic economics says that these two claims cannot both be true. 

According to Keynesian economics, increasing aggregate demand will boost both inflation and the economy. If increasing the minimum wage can create 140,000 new jobs, then basic economics stipulates that it can also result in higher prices. 

In the long-term, the aggregate-supply curve is perfectly vertical, which means that an increase in aggregate demand only increases prices, not GDP. The vast majority of economists believe, however, that the short-term aggregate-supply curve is upward-sloping. This is because companies respond to higher prices, in the short term, by increasing production. (In the long term, producers only respond to improvements in productivity, since prices increases get reflected in firms’ costs.)

Since the short-term aggregate supply is upward-sloping, an increase in aggregate demand will increase real GDP and inflation. (For a graphical representation of aggregate supply and aggregate demand, see here.) The only way that an increase in aggregate demand could increase GDP and not increase prices is if the aggregate supply curve were perfectly horizontal. This is highly implausible – it is a basic economic fact that higher prices cause companies to increase production. 

If increasing the minimum wage can appreciably increase real GDP, then, by definition, it can also increase inflation. Unless liberals are willing to deny a basic tenet of Keynesian economics, then they should drop this ridiculous talking point.