Let's Call The Minimum Wage Hike What It Is: A Massive Stimulus Package

President Barack Obama proposed a $1.75 increase in the minimum wage during his State of the Union speech, which would raise the labour price floor from $7.25 per hour to $9.00 per hour. 

The amount of academic and economic research on minimum wage movements is immense, and often conflicted. First, the U.S. minimum wage has historically exceeded the proposed increase multiple times in its history, and as it stands the federal minimum wage is significantly lower than many other comparable western economies. A number of the nation’s largest employers rely on minimum wage employees to sustain margins.

Second, studies cast doubt on the potential impact of a wage increase on employment, but at the same time other studies indicate that a minimum wage increase has historically discouraged certain key demographics from entering the labour market. 

Still, it’s crucial to call the minimum wage hike what it really is: a comprehensive, dispersed stimulus package that doesn’t cost the government a dime. 

A February 2011 study from the Federal Reserve Bank of Chicago analysed the impact of a $1 increase in the minimum wage on spending behaviour from those affected. 

What they found was surprising. Following a minimum wage hike, groups affected by the raise used their new funds to invest in durable goods like cars and other investments. 

In each category, debt increases after a minimum wage increase, but particularly in collateralized loans tied to vehicles. We estimate that a $1 minimum wage increase causes auto loan balances to increase by $205 […] Furthermore, home equity lines, which can be used to purchase vehicles, rise be $130. Auto loans, home equity, and credit card debt combined increase by $440.

There is no increase in debt among higher income (≥ $20, 000) individuals.

The point is that following an Obama increase in the minimum wage, retailers of durable goods like cars, consumer electronics and home appliances may see a spike in sales as beneficiaries have new cash to make investments in their life. 

Also of interest is the timeline for these investments. Check out this chart:

spending after minimum wage

Photo: Chicago Fed

Here’s what it means:

While total spending is flat prior to the minimum wage increase, this masks an
offsetting increase in non-durables and services (dashed red line, figure 2a) and a decline in durables spending (dotted green line, Figure 2a). When the hike occurs at t=0, durables spending spikes up. Though non-durables and service spending increased two quarters before the hike, it does not increase further during the quarter of the hike.

Spending happens in the first quarter of the minimum wage hike. This is a closer look at spending:

spending after minimum wage

Photo: Chicago Fed

Moreover, most of this spending is in durable goods:

spending after minimum wage

Photo: Chicago Fed

And spending on non-durable goods stays generally flat:

spending after minimum wage

Photo: Chicago Fed

Here’s another look at the quarterly changes in debt as measured by the credit bureaus after a minimum wage hike for nine quarters.

Total debt rises in the first year after a minimum wage hike for households with income below $20,000 but not for higher income households. In subsequent years, debt rises for a bit and then begins to fall as the purchases made following the initial investment period are paid off:

spending after minimum wage

Photo: Chicago Fed

Finally, here’s a look at what the paper eventually found. In the year before a wage increase, households that will be affected typically reduce purchases of durable goods.

Then, following the increase, households seeing a $1 per hour raise invest in durable goods, potentially using money saved up during the preceding quarters as seed money for a down payment. Households then use the raise to pay off these loans:

spending after minimum wage

Photo: Chicago Fed

Here’s the whole point of analysing these decisions.

As much as President Obama painted the minimum wage hike as a moral issue, the reality is much more complex. Following a minimum wage increase, durable goods manufacturers will see increased revenues derived from the new liquidity in the market, having similar impacts as a stimulus.

The minimum wage increase of $1.75 could have major positive impacts, therefore, on the economy.

In short, if the president wanted everyone to buy a car, hiking the minimum wage is a really good place to start. 

Read the full working paper here

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