Promote Purchasing Power—Not the Minimum Wage
How to help working families the most
During a focus group session on working class families we recently conducted at the Georgia Center for Opportunity, Jazmine* made an observation more perceptive than most experts.
Our focus group consisted of working-class African-Americans who did not have a college degree and who were not employed in a managerial position nor on track to become a manager.
Knowing financial stress up close, Jazmine essentially said that either the minimum wage should be increased or the cost of living should be lowered.
Her observation is a perfect segue from my prior blogs on:
- the empirical economic evidence against the minimum wage,
- why the minimum wage is bad news for small business and the overall economy, and
- alternative strategies to the minimum wage that help everyone, instead of just some workers at the expense of others.
The Success Sequence provides an outline of how to reverse the cycle of poverty in our communities. GCO uses this as a framework for much of our work.
Promoting Purchasing Power
The Employment Act of 1946 declared it is the policy and responsibility of the federal government to:
“promote maximum employment, production, and purchasing power.”
Promoting purchasing power means lowering the cost of living, as Jazmine suggested.
Solidified in the 1951 Accord with the Treasury Department, the responsibility ultimately fell to the Federal Reserve to conduct monetary policy as we know it today.
How well has the Fed done with promoting purchasing power? Horribly, quite frankly.
Since 1951, prices have increased 3.4% annually on average, as measured by the geometric mean. In other words, the price level was tenfold higher in 2020 than in 1951. Prices doubled each generation.
It is widely accepted that the poor suffer most from inflation because they spend a higher portion of their income on necessities, and their income growth typically lags others.
For example, according to the most recent mid-year consumer expenditure report from the Bureau of Labor Statistics, consumers in the lowest income quintile spend 82.2 percent of their income on housing, transportation, food, and healthcare, compared to 64.4 percent for the highest quintile. A five percent inflation rate would cost those in the lowest quintile an additional $1,156 for these items on a budget that is already tight, averaging $28,141. A 10% inflation rate would double those costs to $2,312.
Worse, those in the lowest quintile are unable to save for their future, and inflation erodes away the value of the little savings they do have. Consider that on average, those in the lowest quintile purchased only $563 in personal insurance or toward their pensions, compared to $19,736 for those in the highest quintile. This disparity guarantees the poor will be inadequately prepared for retirement or unforeseen loss or tragedy.
Prior to the federal government taking on the responsibility of promoting purchasing power, prices not only remained fairly stable but actually decreased during times of relative peace. Typically, they only increased dramatically during times of war.
This pattern can be seen visually in the accompanying chart using the Consumer Price Index and related data from the Federal Reserve Bank of Minneapolis. For example, the price level increased 24% due to the War of 1812 but then deflated 57% over 47 years until the start of the Civil War, even after accounting for a slight bump up due to the Mexican War.
The pattern was similar for the remainder of the century. Prices increased 74% during the Civil War but then deflated 47% to its pre-Civil War level until the start of the 20th Century.* Although the price level rose somewhat during the progressive era, it was still 30% lower at the start of World War I than at the close of the Civil War.
America’s inflationary policy
Unfortunately, a 1978 law changed promoting purchasing power to become the lame “reasonable price stability,” which is not the same thing.
Over the years, the Fed has allowed inflation as a matter of policy. In 2012, Fed Chairman Ben Bernanke explicitly stated for the first time an inflation target of 2% per year. If the Fed can somehow hold to this target, which it has not been able to do historically, it equates to doubling the price level every 35 years. Last August, it backed away from this policy. Because of all the pandemic spending and monetary expansions, the Fed approved a policy to allow inflation to rise “modestly” above its 2% target.
It is not just the Fed that has shied away from promoting purchasing power. In 1978, and in the midst of the stagflation years, Congress legislated the modest goal that inflation should be 3% or less, but the target rate was supposed to come down to zero percent by 1988 unless it might have impeded employment.
The Fed is not alone to blame for the inability of the federal government to control inflation. Congress’s lack of fiscal discipline resulting in soaring budget deficits place the Fed in a tenuous position to keep interest rates low so federal debt service costs also remain low. Furthermore, recent Fed direct purchases of Treasury debt because of all that federal spending adds to the money supply, eroding—not promoting—purchasing power.
How Congress can better help the average working family
If economics has any immutable law, it must be that you can’t get something out of nothing. This explains why the Consumer Price Index increased 5.4% since last year, as announced today by the Bureau of Labor Statistics. And the rate of increase appears to be accelerating. The monthly rate was 0.6% in May but 0.9% in June. If this June inflation rate persists, and hopefully it does not, we will have double digit inflation. A 0.9% monthly rate equates to an 11.4 % annual rate.
Considering all the recent deficit spending by Congress and expansionary policies by the Fed, expect more of the same, or worse. In fact, according to a survey of economists in yesterday’s Wall Street Journal, “Americans should brace themselves” because economists are waking up to the prospect of higher inflation, expecting “brisk price increases for a while.”
Economic history indicates deflation should be the norm. In fact, innovation spawns increased productivity that allows prices to fall, which should show up as deflation. We have the opposite: productivity gains with inflation. This outcome places the blame squarely on monetary and fiscal policy.
In the meantime, Jazmine and other hard working Americans struggle to keep up with rising prices. Instead of pushing for increases in the minimum wage that help some at the expense of others, Congress needs to renew our nation’s purchasing power policy and get its fiscal house in order.
*Jazmine’s last name withheld for confidentiality.
*This is not intuitive. It takes a smaller percent decrease to offset a percent increase, such as a 43% reduction will offset a 74% increase. For example, suppose you receive a 20 percent pay raise this week, but next week you receive a 20 percent pay cut. Are you back where you started? The answer is no; you are worse off. If your weekly pay was $100, the increase took you to $120, but then your pay cut took you to $96, even lower than your starting point.
Erik Randolph is the Director of Research at the Georgia Center for Opportunity.