The Minimum Wage Debate, 15th Oct 2014

Far be it from me to be watching BBC Parliament during my lunch hour…

But I nearly choked on my chilli as I listened to MP Alec Shelbrooke saying that we shouldn’t raise the minimum wage because it would cause inflation.

My instinct was to write an angry but not particularly well reasoned blog. But now I’ve got over myself, I thought I’d look at the suggestion properly.

Firstly, will raising the minimum wage create inflationary pressure?

Secondly, will it matter?

A starting point is the Phillips Curve which indicates that governments have to make a pay off between inflation and unemployment. In the current UK economy where unemployment is falling, with no reactionary inflation (currently 1.2% and falling with target rate at 2%), we could certainly allow a little wage based pressure.

[Since writing this, Krugman has commented on low inflation in the Eurozone. Click here for more.]

Is this a dangerous tactic?

Well, let’s look at the unique context in which we’re making these decisions.

The Low Pay Commission estimates that there are 1,386,000 minimum wage jobs. So if everyone on minimum wage was full time, that makes about £16 billion in annual salaries. A 50p per hour increase would result in an approximate 1.2 billion a year. As opposed to the quantitative easing total of £375bn! To put this in a larger context, GDP is about £1.6 trillion so a raise of 50p would amount to about 0.07%. (And that’s assuming that everyone on minimum wage is working full time.)

Over the last few years monetary expansion/ quantitative easing / the buying up of financial assets – whatever you call it, has been a key strategy to warm up a moribund economy. The purpose? To pump cash into the economy. Has there been reactionary inflation? No.

But as soon as the suggestion is made that the less well off might get a sniff of some of that cash, the right wing panic alarm goes off.

The assumption must be that pumping liquidity into the financial industry is OK, because they can be responsible with that cash. Whereas people earning minimum wage will only go and spend it – the rotters!

Of course, the point of the Bank of England putting cash into the economy was for it to be distributed / spent / invested. But it has not been efficient as the financial sector, in its understandable apprehensiveness, has held onto the cash. (Big word name: liquidity crisis.) As mentioned in a previous blog, the money would have run through the pipes into the rest of the economy much more efficiently and egalitarianly if the cash had been distributed through institutions that had no incentive to hoard.

Shelbrooke could be right about some inflationary pressure being caused. There hasn’t been any so far as a result of the QE and monetary expansion cash being held back. But I have a feeling that if some confidence does return to the financial sector, that cash that has been hoarded up until now will start getting spent – and that will be a big driver of inflation.

Sadly for the knee jerk right wing the suggestion that we shouldn’t raise the minimum wage will not prevent the potential inflationary pressure when the stored up cash gets released – it will merely prevent any progress reducing the distance between rich and poor.

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