Aggregate Effects of Minimum Wage Regulation at the Zero Lower Bound

Abstract

The Fair Minimum Wage Act of 2007 increased the U.S. nominal minimum wage by 41 percent, just as interest rates hit the Zero Lower Bound. I study the interaction of these events in a parsimonious extension of the sticky-price New Keynesian model with heterogeneous labor. A “minimum-wage augmented” Phillips curve relates inflation to output and the real minimum wage, which I estimate with aggregate data. Consistent with theory, controlling for the real minimum wage reduces the effect of output on inflation and increasing the minimum wage is inflationary. I then calibrate the equilibrium model to match microeconomic elasticities of earnings with respect to the minimum wage. On aggregate, the ZLB’s contractionary effects are dampened because nominal wages cannot decline rapidly, thereby halting the deflationary spiral caused by low aggregate demand. The effect can be large - in the calibrated economy, GDP losses from the ZLB are cut by half, even though only 3% of earnings accrue to minimum wage earners. Furthermore, increasing the minimum wage at the ZLB is expansionary, generating expected accumulated output gains of 14%

Keywords: Minimum Wage; Zero Lower Bound; Monetary Policy

JEL Classification: E52; E12; E24