Unraveling the Relationship Between Inflation and Salary Growth

Growing inflation has been the source of much conversation in the past three years. Much of the conversation revolves around how inflation impacts wages. A recent article in Forbes provides some good analysis around why salary increases do not always align with inflation.

By Kevin Marrs, courtesy of SBAM-approved partner, ASE

Several factors contribute to the variance between inflation and salary increases:

Different Definitions: Inflation and salary increases are driven by distinct inputs. Inflation is based on changes in the cost of goods in a market, while pay is influenced by changes in labor supply and demand, driven by factors such as demographic trends, unemployment levels, technological advancements, and productivity growth. Consequently, there can be a disconnect between inflation rates and wage increases. For example, during the highest peacetime inflation in 1979 (13.3%), wage increases were much lower at 8.7%. Conversely, in 2001, with inflation at 1.9%, salary increase budgets were around 4%. This discrepancy can lead to perceptions of real spending advantages during low-inflation years and disadvantages during high-inflation periods.

Role of Benefits: Increases in employee benefit costs (e.g., healthcare and retirement plans) are not typically factored into salary increase budgets but contribute to overall employer spending. While these costs influence inflation, they are often overlooked when discussing salary increases. In many cases, employer spending on employee programs exceeds inflation, with salary being just one component.

Pay Stickiness: Pay increases are “sticky” in labor economics, meaning they are challenging to reduce when markets decline and slow to rise before long-term implications are assessed. During the COVID-19 pandemic, most employers did not reduce individual salaries despite a spike in the U.S. unemployment rate. Similarly, as inflation declined, employers refrained from reducing salaries. During the tight labor market in 2021 and early 2022, many employers raised salaries for high-demand jobs while maintaining overall pay levels. This cautious approach proves beneficial when economic conditions fluctuate.

Lagging Indicators: Both salaries and inflation are lagging indicators, with a delay before their interaction is fully understood. Increases in individual pay levels during the pandemic were influenced by higher starting salaries to attract new workers and significant raises for those switching jobs during The Great Resignation. However, the full extent of these changes was only grasped later. Additionally, certain measures of inflation, such as housing costs, exhibit substantial lags, leading to overstated inflation during specific periods.

The intricate relationship between salary increases and inflation persists under changing economic landscapes. Understanding the nuances and factors influencing this interplay is essential for organizations and individuals alike, as they navigate the complexities of compensation and workforce management.

ASE has closed its 2023/2024 Salary Budget Survey and expects to have results available in mid-August.  Members will be able to access those results at no cost from their Member Dashboard.