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Study Finds Proposed Minimum Wage Hike Would Boost Economic Growth in Short Run

Wednesday, July 10, 2013
The $1.75 per hour increase in the federal minimum wage proposed by President Obama on balance would stimulate economic growth in the short run, because it would put more money into the hands of households with a greater propensity to spend it, according to a recent Chicago Federal Reserve Bank analysis.

Approximately 13 percent of the workforce, or 15 million workers, earn $6 per hour to $9 per hour--which is at or close to the current minimum wage of $7.25 per hour, Daniel Aaronson, Chicago Fed vice president, and Eric French, senior economist, said June 27 in the monthly Chicago Fed Letter.

In addition, 7 million workers who currently earn $9 per hour to $10 per hour likely would receive small raises from their employers in response to the hike in the minimum wage to $9 per hour, also benefiting consumer spending, they said, based on an analysis of Labor Department data.

The 22 million low-wage workers would receive an additional $30 billion per year in income and would boost their spending by an even larger amount in the first year following the hike in their wages, they said.

On the other hand, employers of low-wage workers would compensate for the higher labor costs by reducing employment and raising consumer prices, they predicted.

Even so, the increase in spending by employed minimum wage workers would be greater than the loss of jobs and spending power for other workers, resulting in a net increase in the nation's real gross domestic product of $28 billion in the first year, or 0.2 percent of real GDP in 2012, they found.

“We are skeptical that minimum wage hikes boost GDP in the long run,” Aaronson and French wrote. “Nevertheless, we do find evidence that putting money into the hands of consumers, especially low-wage consumers, leads to predictable increases in spending in the short run.”

Obama in his State of the Union address in February urged Congress to raise the federal hourly minimum wage to $9.00 from $7.25 in stages through 2015 (30 DLR AA-1, 2/13/13).

More Cars Bought on Credit
The boost to consumer spending from a minimum wage hike arises from differences in the propensity to spend among different income groups, according to the study.

Previous analyses by the Chicago Federal Reserve Bank found that real spending in households with adult minimum wage workers rises by an average of about $700 per quarter during the first few quarters following a $1 per hour hike in the hourly minimum wage.

That additional spending, primarily on new motor vehicles and other durable goods, is greater than the income gain of $250 per quarter from the wage increase because many lower-income households leverage their pay raise by financing such purchases with credit.

For example, if used to meet a requirement for a 20 percent down payment, $250 can be leveraged up to $1,250 in total purchases.

The gain in household spending from an increase of $1.75 in the hourly minimum wage would boost consumer spending by roughly $48 billion the first year, or 0.3 percent of 2012 real GDP.

On the other hand, a 10 percent increase in the minimum wage would reduce employment of adults and teenagers earning the minimum by 2.5 percent and 5.0 percent, respectively, the researchers estimated.

The economic costs of job losses and higher consumer prices resulting from a $1.75 per hour minimum wage hike would offset part of the increased spending by lower-income households, resulting in a smaller real GDP gain of $28 billion, or 0.2 percent.

The authors of the study stressed that this economic gain would only last for the first few quarters following the wage hike.

“Beyond that time frame, households must pay off debt they incurred in the short run,” and their spending declines, they said. “Thus, a minimum wage hike provides stimulus for a year or so, but serves as a drag on the economy beyond that.”

The net impact on real GDP over the long run is “close to zero,” they concluded.

The report is available at /uploadedFiles/Content/News/Legal_and_Business/Bloomberg_Law/Legal_Reports/Chicago-Fed-Letter-Aug.-2013(2).pdf.

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