A Dynamic Equilibrium between Inflation and Minimum Wages in Sri Lanka

Abstract

This paper explores the dynamic equilibrium between minimum wages and inflation in Sri Lanka. From a theoretical perspective, while minimum wages tend to be sluggish in the economy, changes in price levels are compulsive. This empirical investigation which includes causality, co-integration and error correction models, reveals the existence of a long-term equilibrium relationship between minimum wages and inflation, and a one-way causality between the two variables. An interruption in equilibrium leads not only to a significant adjustment process but also to structural changes in long-run equilibrium. Finally, macroeconomic stability is established through the impulse response function in a situation, where shocks are applied to both minimum wages and inflation. The study recommends policy-making entities contemplate a minimum wage adjustment process in a climate of unstable inflation.