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

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.