What Happens to Jobs When Minimum Wage Increases Are Tied to Inflation?

Economists have been studying how minimum wage increases affect employment for a long time, but indexing the minimum wage to inflation is a relatively new, less understood policy. Peter Brummund and Michael Strain wanted to learn whether indexing the minimum wage to inflation leads to different employment effects. Specifically, they asked whether the employment response to a minimum wage increase is different in states that index their minimum wages to inflation compared to those that don’t.

What did they find? On balance, indexing the minimum wage to inflation reduced employment. They found that the effect on the level of employment in states that index their minimum wages to inflation is around three times the magnitude of the effect of minimum wage increases in states that do not index.

Because consumer prices on the whole typically increase each year, the real (inflation-adjusted) value of nominal minimum wages decreases each year. Firms know this, so they may consider typical, one-off, nominal minimum wage increases to be a temporary increase in the cost of production. Firms may be more reluctant to make changes to their workforce and other aspects of their production functions in the face of a temporary increase than they would be when facing a permanent increase. In addition, the decision of entrepreneurs to start businesses and of existing firms to leave the market may be affected.

According to the authors, in other words, “Our findings suggest that firms do respond differently, and more aggressively, to ‘permanent’ increases in the minimum wage.” They also studied the dynamics of the response and found the differential employment response to minimum wage increases lasts for 14 quarters following the implementation of the indexing policy. This dynamic response is consistent with adjustments to “permanent” minimum wages that might take place within firms and within industry.

Read the full study in the Journal of Human Resources: “Does Employment Respond Differently to Minimum Wage Increases in the Presence of Inflation Indexing?” by Peter Brummund and Michael R. Strain

Peter Brummund (@pb_econ) is at the University of Alabama. Michael R. Strain (@MichaelRStrain) is at the American Enterprise Institute.