How to Create More Inflation?

American economy has been struggling to recover from the Great Recession of 2008. Economists, policy makers, political leaders of the US have tried their best to end this recession as soon as possible. The US resorted to humongous fiscal spending, unconventional monetary policy. Yet, it is far behind its pre-crisis level when it comes to major economic indicators. To help recover the economy, New Keynesians, on the other hand, suggested higher inflation can do this job. The logic is simple: consumers would find spending now is prudent. People buy more and companies accelerate investments when things cost less today than tomorrow. Another benefit is that it makes your debt payments easier. So, how can we create more inflation? Well, some economists say the central bank should announce that it wants higher inflation. This announcement if perceived credible by public, they argue, is enough to take the economy to a higher inflation regime. And if does not, then central bank should be ready to act, that is, loosely speaking by printing more money. The Fed should go for an expansionary policy sufficient to raise the inflation that the Fed wants.

Yet, some argue engineering inflation by the Fed is not as easy as its advocates argue. Well, issues like political differences between Democrats and Republicans, credibility, time inconsistency, and reputation come into picture that makes the matter worse. For example, if inflation slips from the Fed’s control, then it has to create another recession to end higher inflation.

If we want more inflation raising the minimum wage, I think, will do that. So, if higher wage gets reflected in higher prices (in fact, it has some evidence), Keynesians argue, would lead to a rise in demand. And this brings cheer to New Keynesians since they argue that inflation can serve as a panacea to a zero-bound constrained economy.

But then why raise the minimum wage and distort the labour market? You will be tempted to think it may result in higher unemployment. The arguments for raising minimum wage are (a) minimum wage in the US has been kept on freeze since July 2009 (b) raising minimum-wage would provide a much-needed boost to the earnings of low-wage workers; that is it would raise standard of living and further, it would have a spillover impact on workers whose wages are just above the new minimum, (c) thus it would reduce poverty, (d) inequality has been sharply increasing and (e), wage has been slowly falling, though latest data suggest it is slowly rising. It might also lead to rise in productivity.

Okay. But what about its impact on unemployment? A large chunk of the research carried out by economists showed that it has zero or negligible impact on the employment of minimum-wage workers. But one thing that is missing in the current debate on minimum wage is that it might lead firms to substitute labor by capital.

Those who oppose this move argue that raising minimum wage is not a ‘panacea’ that can fix the economy. They argue rise in labor costs would cost employment. That is, firms would remove some of their workforce. I think they don’t take into account of employment addition due to rise in demand coming from hiked minimum wage. Further, they argue that increased wage would be visible in higher product prices. Another point they raise is that higher minimum wage would not substantially help the poor since many low-wage workers are not members of low-income families.

But i have two objections to the arguments made by the proponents of raising minimum wage: First, if wage is falling then we should see more jobs being created and recovery of the economy.  After all, Keynes said in 1936 that markets could not clear because wage (and price) was sticky. According to Keynesian camp, this was the major cause of protracted depression. So, falling wage is good sign that Keynesian devotees should cheer about. Second, what guarantee is there that hiked minimum wage would propel wage earners to spend more given that uncertainty remains high? They might choose to save if they are rational and far-sighted. We have evidence that they saved a lot from transfer payments.

Fair enough. So we learned from both these camps is this: a higher minimum wage will lead to increased money income in the hand of low-wage earners. So they would spend more. Further, firms would raise their prices to offset higher cost of labor. At the same time, firms might reduce hiring of labor and in fact reduce workforce. However, the balance of evidence suggests that rise in minimum wage have had negligible or no negative effect on the employment.

So, we have three benefits: inflation-induced higher demand, higher minimum wage-induced higher demand and rise in productivity; and one cost: rise in cost of labor. The biggest benefit is that no citizens will oppose it. That means tacitly they are favouring a higher inflation. Citizens will never allow raising inflation even if it is best for the economy and consumers. Hence minimum wage increase is the easiest solution to engineer inflation.