By Daniel Brouse
June 11, 2024
The two major contributors to today’s inflation that a President can influence are insufficient immigration and federal budget deficits. Both Trump and Biden administrations have played significant roles in these issues.
Through May of 2024, average hourly wage growth has exceeded inflation for 12 straight months.
Economic Facts on Inflation and Wage Inflation
Current Impacts of Wage Inflation
1. Increased Consumer Prices: Wage inflation leads to higher costs for businesses, which often pass these costs onto consumers in the form of higher prices for goods and services. This contributes to overall inflation, affecting the purchasing power of consumers.
- Consumer Price Index (CPI): Rising wages can lead to an increase in the Consumer Price Index, a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. When wages increase significantly, the CPI often follows suit.
- Examples: Recent data has shown significant price increases in various sectors, including food, housing, and healthcare, driven in part by higher labor costs .
2. Business Profit Margins: Higher wages can squeeze profit margins for businesses, particularly in labor-intensive industries. Companies may face challenges in maintaining profitability if they cannot pass the increased costs onto consumers.
- Impact on Small Businesses: Small businesses, which often operate with thinner profit margins, may struggle more than larger corporations to absorb the increased costs associated with wage inflation. This can lead to reduced hiring or even business closures in extreme cases .
- Corporate Responses: Larger corporations might respond by investing in automation and technology to reduce dependency on human labor, thereby mitigating the impact of wage inflation on their bottom lines .
3. Employment and Job Market Dynamics: Wage inflation can have mixed effects on the job market. While higher wages can attract more workers and reduce turnover, they can also lead to cost-cutting measures such as layoffs or reduced hiring.
- Job Cuts and Automation: Some businesses may reduce their workforce or turn to automation to manage increased labor costs. This can result in job losses or slower job growth in certain sectors .
- Labor Force Participation: On the positive side, higher wages can draw more individuals into the labor force, potentially reducing unemployment rates and increasing overall economic productivity .
4. Economic Inequality: Wage inflation can impact income inequality in various ways. While higher wages can improve living standards for low- and middle-income workers, the overall benefits may be unevenly distributed.
- Living Wage Increases: Efforts to raise the minimum wage or provide living wages can significantly benefit low-income workers, improving their economic stability and reducing poverty levels .
- Disparities: However, wage inflation can exacerbate disparities if high-wage sectors see more significant increases compared to low-wage sectors, potentially widening the gap between high and low earners .
Economics of Immigration and Wage Inflation
1. Wage Inflation as a Driver of Overall Inflation: Wage inflation occurs when wages increase, leading to higher costs for businesses, which often pass these costs onto consumers through higher prices for goods and services. This process contributes to overall inflation, which is the rate at which the general level of prices for goods and services rises.
- Impact on Businesses: When wages increase, businesses face higher labor costs. To maintain profitability, they may increase the prices of their products or services, contributing to inflation.
- Consumer Purchasing Power: As prices rise, the purchasing power of consumers can decrease unless wage growth keeps pace with inflation. This dynamic can create a cycle where higher wages lead to higher prices, which then necessitate further wage increases.
2. Insufficient Immigration as a Contributor to Wage Inflation: Immigration plays a critical role in the labor market by providing a supply of workers that can help meet demand in various industries. When immigration levels are insufficient, it can lead to labor shortages, which in turn drive up wages as employers compete for a limited pool of workers.
- Labor Market Dynamics: A decrease in immigration can exacerbate labor shortages in key industries such as agriculture, construction, and healthcare. This shortage forces employers to offer higher wages to attract and retain workers.
- Economic Growth: Insufficient immigration can limit economic growth by restricting the labor force available to support business expansion and innovation. This constraint can lead to increased costs for businesses and higher prices for consumers.
Sources and Further Reading:
- Wage Inflation and Its Impact:
- Federal Reserve Bank of San Francisco. (2022). “Wage Growth and Inflation: Insights from Economic Research.”
- U.S. Bureau of Labor Statistics. (2023). “Wage Growth and Its Implications for Inflation.”
- Immigration and Labor Market:
- National Bureau of Economic Research. (2021). “The Effects of Immigration on the United States Economy.”
- Pew Research Center. (2022). “U.S. Immigration Trends and Workforce Impact.”
Expanded Explanation
Wage Inflation as a Top Driver of Overall Inflation:
- Economic Theory: According to the cost-push inflation theory, when wages rise, production costs for companies increase. These companies, in turn, raise prices to maintain profit margins, leading to higher overall inflation.
- Historical Context: Historical data shows periods where wage increases have led to significant inflationary pressures, such as during the 1970s in the United States, a time characterized by high inflation and wage growth.
Insufficient Immigration and Its Role in Wage Inflation:
- Labor Supply: Immigration contributes to the labor supply, particularly in sectors that rely heavily on immigrant workers. When immigration is restricted, these sectors face labor shortages, pushing wages higher.
- Economic Integration: Immigrants often take jobs that are complementary to those held by native-born workers, enhancing productivity and economic growth. Insufficient immigration can disrupt this balance, leading to inefficiencies and higher costs.
- Policy Implications: Policies that restrict immigration can have unintended consequences on the labor market and inflation. Understanding the balance between immigration and wage dynamics is crucial for policymakers aiming to manage inflation and economic growth effectively.
By examining these factors, it becomes clear that both wage inflation and immigration policies play significant roles in shaping the economic landscape, influencing both inflation and broader economic performance.
How Federal Budget Deficits Impact Inflation
The federal budget deficit has increased under both Trump and Biden due to a combination of tax cuts, increased spending, and the economic impact of the COVID-19 pandemic. While Trump’s administration saw a significant increase in the deficit due to tax cuts and pandemic relief measures, Biden’s administration has continued high levels of spending on recovery and infrastructure.
1. Increased Aggregate Demand: Federal budget deficits typically occur when government spending exceeds revenue. This increased government spending can boost aggregate demand in the economy, leading to higher prices if the economy is operating near or at full capacity.
- Demand-Pull Inflation: When government expenditures increase, it injects more money into the economy. If this additional demand outstrips the economy’s ability to produce goods and services, it can lead to demand-pull inflation, where the overall demand in the economy exceeds the supply, causing prices to rise .
2. Higher Interest Rates: To finance a budget deficit, the government often borrows money by issuing bonds. This increased demand for borrowing can drive up interest rates, as the government competes with the private sector for available funds.
- Crowding Out Effect: Higher interest rates can make borrowing more expensive for businesses and consumers, potentially leading to reduced investment and spending in the private sector. This can mitigate some of the inflationary pressures but can also slow economic growth .
3. Money Supply and Monetary Policy: If the central bank (e.g., the Federal Reserve in the United States) accommodates the deficit by increasing the money supply, this can lead to inflation. An increased money supply can reduce the value of money, causing prices to rise.
- Monetary Policy Response: Central banks may respond to fiscal deficits by tightening monetary policy, such as raising interest rates to combat inflation. This can help control inflation but may also slow down economic growth .
4. Inflation Expectations: Persistent budget deficits can influence inflation expectations. If businesses and consumers expect higher future inflation due to continued deficit spending, they may adjust their behavior accordingly, such as demanding higher wages or increasing prices.
- Expectations and Behavior: Inflation expectations can become self-fulfilling. If workers expect higher inflation, they might demand higher wages, leading businesses to raise prices to cover these higher costs, thus perpetuating inflation .
Sources
- Federal Reserve Bank of St. Louis – Government Spending and Aggregate Demand
- Brookings Institution – How Deficits Influence Inflation
- Harvard Business Review – The Crowding Out Effect
- U.S. Treasury – Effects of Government Borrowing on Interest Rates
- Federal Reserve – Monetary Policy and Inflation
- International Monetary Fund – Fiscal Deficits and Inflation
- OECD – Inflation Expectations
- Bureau of Labor Statistics – Consumer Price Index
- U.S. Bureau of Economic Analysis
- National Federation of Independent Business – Small Business Economic Trends
- Harvard Business Review – Impact of Wage Increases on Small Businesses
- McKinsey & Company – Automation and the Future of Work
- Forbes – The Impact of Automation on Jobs
- World Economic Forum – The Future of Jobs Report
- Pew Research Center – Labor Force Participation
- Economic Policy Institute – Raising the Minimum Wage
- Center on Budget and Policy Priorities – Benefits of Minimum Wage Increases
- Brookings Institution – Economic Inequality
- OECD – Income Inequality
- Economic Update: Inflation, Interest Rates, AI, Consumer Spending, Climate Change, and Fiscal Policy
- Inflation Bites
- Worst Economy Ever: United States Financial Health in 2020 Hindsight
- The Economic Monsters: Inflation and Interest Rates (2018)
- Immigration & Capitalism