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Macroeconomic Effects of the Minimum Wage in an Emerging Economy with Labor Informality

Author

Listed:
  • Oscar Iván Ávila-Montealegre
  • Juan J. OspinaTejeiro
  • Anderson Grajales-Olarte
  • Mario A. Ramos-Veloza

Abstract

We analyze how the minimum wage affects a typical emerging economy with high labor informality. Using an extended New Keynesian small open economy model, we find that an unexpected increase in the minimum wage disproportionately affects low-skilled workers, with limited effects on inflation and the monetary policy rate. A higher minimum wage raises production costs and induces the substitution of formal workers with informal labor and machinery, leading to lower output, employment, and net exports. We also find that the existence of a minimum wage alters the transmission of productivity, demand, and monetary shocks, resulting in a more persistent impact on macroeconomic variables and lower effectiveness of monetary policy in controlling inflation. While the minimum wage mitigates consumption inequality in the short run, it increases employment volatility. The macroeconomic implications of minimum wages are significant, and the mechanisms differ from those highlighted in the literature for advanced economies.

Suggested Citation

  • Oscar Iván Ávila-Montealegre & Juan J. OspinaTejeiro & Anderson Grajales-Olarte & Mario A. Ramos-Veloza, 2025. "Macroeconomic Effects of the Minimum Wage in an Emerging Economy with Labor Informality," Working Papers 2025-018, Banco Central de Reserva del Perú.
    • Handle: RePEc:rbp:wpaper:2025-018
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    Keywords

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    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J46 - Labor and Demographic Economics - - Particular Labor Markets - - - Informal Labor Market

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