From 1 April 2026, the UK National Living Wage (NLW) for workers aged 21 and over increased by 4.1% to £12.71 per hour. Nikolaos Kokonas at the University of Bath explains how this could increase consumer spending, support jobs and help lower-income households, but the effect will depend on the state of the wider economy. In the current UK climate, where cost pressures are persistently high, the overall impact is likely to be modest.
State dependence in minimum wage policy
The UK government’s recent 4.1% increase in the minimum wage has reignited a familiar debate: will higher pay help workers without putting jobs at risk, or will it push up costs, fuel inflation and lead to job losses? This question matters for millions of households who rely on minimum wage work. The answer depends largely on the state of the economy.
Research looking at individual regions or sectors has generally found that higher minimum wages do not lead to large job losses. These studies deliver credible causal estimates by focusing on small-scale changes and holding the wider economy constant, thereby isolating the effect of wage increases from other economic feedbacks. The prominent work of Card and Krueger (1994) emphasises this, finding little to no adverse effects of minimum wage increases on employment.
In reality, however, things are more complex. A rise in the minimum wage not only affects individual workers and firms, but also influences spending, prices and expectations across the economy. Because of this, the impact of higher wages depends on the state of the economy and the constraints that are currently holding it back.
Broadly speaking, there are two possibilities. If the economy’s main problem is weak consumer spending (low consumer demand), then higher wages can help by giving low-paid workers more money to spend, which can support businesses and jobs. This applies to economies that exhibit Keynesian features, where output is determined by demand. But if businesses are already struggling with high costs or finding it difficult to recruit staff (labour scarcity), then higher wages may add to those pressures and limit hiring. It’s possible, even, for higher wages to cause job losses.
In economic theory, this follows the general disequilibrium tradition, recently revisited by Barro (2025). This approach is well established, though it misses an important signal: the stance of policy.
An important clue in understanding how higher minimum wages will impact the economy comes from recent policy decisions, especially interest rates (monetary policy). This is because making inferences about the state of the economy from prices and employment alone overlooks how policymakers themselves interpret current economic conditions and priorities. Policy decisions reflect how policymakers see the economy in real-time and their assessment of its underlying constraints. For example, when the Bank of England raises interest rates, it signals an attempt to ease cost pressures and control inflation. When it cuts interest rates, it is often trying to encourage spending.
My earlier work within the general disequilibrium tradition (Kokonas, 2016) builds on this insight. I show that in Keynesian environments, where spending is weak, lower interest rates (looser monetary policy) can boost consumer demand and help higher wages feed through into more jobs. But when high costs are the main issue in the economy, higher interest rates (tighter monetary policy) are used to keep inflation under control, thereby stabilising economic conditions.
The key point is simple but often overlooked: the effects of minimum wage increases depend on economic conditions. In other words, minimum wage policy is state-contingent.
The UK economy since 2021: What the data show
Between 2021 and 2023, the UK economy showed clear signs of strain on the business side (cost pressures and labour scarcity; a non-Keynesian environment). Unemployment was low, falling below 4%, with job vacancies reaching a record high of around 1.2-1.3 million while inflation exceeded 10%. At the same time, the Bank of England sharply increased interest rates from 0.1% to 5.25%. Together, these suggest that businesses were facing rising labour costs and shortages of workers.
More recently, the picture has changed. By 2025-2026, unemployment rose to around 5.2% and job vacancies fell to roughly 700,000. Inflation came down. The CPI (Consumer Prices Index) measure of inflation lowered to roughly 3% in 2025 and around 2.5-3% in 2026, but remains above the Bank of England’s 2% target. Interest rates have been cut to around 3.75% in 2026, down from their 5.25% peak in 2023, but they remain relatively high despite recent easing. Household spending has also weakened relative to its strong rebound after the COVID-19 pandemic. Taken together, this points to a mixed picture: policy is gradually loosening but consumer demand has softened and pressures on businesses have not fully disappeared.
In this environment, minimum wage policy operates under countervailing forces. On the one hand, positive effects on employment could be observed through increased consumption—higher wages support spending and jobs. On the other hand, ongoing cost pressures may make firms more cautious about hiring. As a result, the overall impact on employment is likely to be modest and could turn negative if cost pressures outweigh the boost to spending.
Key takeaway for policymakers
The question is not whether higher minimum wages are inherently good or bad in general, but what is currently holding the economy back. If the main issue is weak household spending, higher wages can help by boosting consumer demand and supporting employment. But if businesses are under pressure (facing high costs or difficulty hiring workers), then higher wages are more likely to add to those pressures, with little or no benefit for jobs.
The main takeaway is straightforward: minimum wage policies should depend on economic conditions and cannot be set independently of analysis of the macroeconomic environment. This is broadly in line with how the Low Pay Commission sets the minimum wage. It looks at a wide range of labour market and macroeconomic evidence, and recommends increases only when risks to employment are judged to be limited.
In the UK economy today, where consumer spending has weakened but cost pressures and inflation persist, these forces can offset each other. As a result, the overall impact of the recent 4.1% minimum wage increase on employment and consumption is likely to be modest — and could even be negative if cost pressures dominate.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.
