By Andrew Glover
The Fair Minimum Wage Act of 2007 increased the U.S. nominal minimum wage by 41 percent immediately prior to nominal interest rates hitting the Zero Lower Bound in 2008. I study the interaction of these two events in an extension of the sticky-price New Keynesian model. The minimum wage dampens the contractionary effects of the ZLB by preventing rapid wage deflation, halting the deflationary spiral caused by low aggregate demand. For sufficiently persistent ZLB shocks, the minimum wage generates infinite output gains relative to flexible wages, while GDP losses are reduced by half in a calibrated economy. Increasing the minimum wage at the ZLB is expansionary: accumulated output gains are more than 15 percent in the calibrated economy.
Interesting. I can believe that increasing the minimum wage is expansionary, after all the beneficiaries have a very high propensity to consume. And this becomes particularly important when you hit the ZLB, as policy options are running out. I would not have expected this to that effective a policy.