How Does Inflation Affect Salary Increase

Camino Financial09 Jan 2024
How Does Inflation Affect Salary Increase

Considering how inflation affects salaries, it's important when you're thinking about the future of your career and financial security. This powerful economic force affects the exchange rate of goods and services. But how can this impact you?

This article is here to provide some insight into the matter. By understanding how inflation works, you can make more informed decisions about your salary increase.

Wages vs. Inflation: The Effect On Salary Increases

Inflation Can Affect How Much Your Salary Increases

Salary increases should take into account inflation. When a worker gets a raise, the visible paycheck increase should increase more than if there were no inflation. This is because businesses know to compensate salaries with higher growth due to the effects of inflation. In a few words, salary budgets should also increase when inflation rises.

Inflation Does Not Have A One-To-One Effect On Employee Wage Increases

The problem is when inflation outpaces the salary increase. In this case, the inflation might even effectively cancel said increase. Inflation can and does negatively affect many Americans in the labor force yearly with high inflation rates. It can mean inconsistent or unexpected purchasing power shifts.

Inflation And Salary Increases Should Follow Similar Trends

Inflation is rising in 2023. Years ago, it was a controllable economic issue, but after a global supply chain crisis, pandemic, and other influencing factors, inflation is back and even more challenging than before. A salary increase should ideally consider inflation and follow similar trends for workers. Otherwise, it can become difficult for workers to afford their living necessities.

Pros And Cons of Pay Raise When Inflation Is Rising

Pros:
  • Your purchasing power will increase if you receive a pay raise when inflation is rising.
  • You'll be able to buy more goods and services with increased income.
Cons:
  • Inflation can erode the value of your earnings, so a pay raise can help offset this effect and keep you ahead of the game.
  • If the cost of living in your area is increasing faster than your salary, a pay raise may not be enough to maintain your standard of living.

How To Calculate A Salary Increase?

Percentage Raise

A percentage increase uses a chosen percentage to increase the salary. The business typically determines the raise percentage. Historically, companies have given their employees a 3% raise, but as of 2023, many companies are budgeting for a 4% salary increase for well-performing employees. The basic formula is:

(Old Salary x Raise%) + Old Salary = New Salary

For example, let's say that your original annual salary is $50,000, and your raise is 4%. Put the values into the formula, and you get ($50,000 x 4%) + $50,000 = $52,000

Flat Raise

This kind of salary raise adds a flat amount to your annual salary. Often, businesses that give flat raises choose a whole number. The formula is:

Old Salary x Raise% = New Salary

For example: Suppose you receive a flat salary raise of $5,000, and your original annual salary was $50,000. Your original weekly wage would be $50,000 / 52 = $961.54. After the flat raise, your new annual salary would be $5,000 + $50,000 = $55,000. Your new weekly salary would be your annual salary divided by 52 weeks, which is $55,000 / 52 = $1057.69.
#CaminoTip Other methods to determine a salary increase exist too. An online salary increase calculator that considers the inflation rate could also assist you in finding out your salary increase.

What Should My Salary Be To Match Inflation Rates?

Your salary should increase at a rate that trends similarly to inflation. That way, you will be able to maintain more purchasing power as the value of your currency depreciates. Businesses commonly use the 3% salary raise percentage to reward their good employees with a raise, but if the inflation rate is high, a higher salary raise might be necessary. As we go into 2024, the salary raise percentage companies need to use might even rise above 4%.
#CaminoTip Don't only use market data, the consumer price index, or the overall average salary increase when you are trying to figure out how much of a wage increase to ask for.

Steps When Raising Employee Salaries

Do Your Research

Ensure you're offering competitive wages by researching the going rates for similar positions in your area. You can use websites like Salary or Glassdoor to understand what employees in your industry are making.

Communicate With Your Team

It's important to inform your team about the salary increases well in advance so they can prepare financially and emotionally. They may have questions or concerns you must address, so open communication is key.

Put It In Writing

Once you finalize everything, make sure to put the new salaries into writing (or at least communicated via email). This way, there is no confusion, and everyone is on the same page moving forward.

Make A Budget

Once you know how much you need to pay your employees, it's time to create a budget. Answer the questions: How much can you afford to increase salaries by? What other areas will this decision impact? Learn how to invest during a recession and tough times

Reasons Why the Salary Increase Is Not Keeping Pace With Inflation

The Sticky Wage Theory

In general, this theory explains how employee wage increases tend to respond slowly to economic changes. The economic term "sticky" refers to being more resistant to change or adjusting slowly.

Inflation And Salary Increases Are Just Not The Same

Unfortunately, inflation and salary increases do not match one-to-one. Companies are likely only raising employee salaries to compensate perfectly for inflation. They may move in the same direction, but different factors drive them, so you may find your salary increase lacking. Often, increased salaries are less helpful after inflation.

New Policies Take Time

The fight against inflation is not a battle you can win overnight. Policies may be necessary to ensure that salary increases can catch up to inflation, but many pressures affect the effectiveness and efficiency of enacting economic policies. Managing salary increases is a complicated topic for all businesses in a tight labor market like these days.

When Inflation Is Unexpectedly High, Businesses Cannot Catch Up

Global or regional events like war and disease can ultimately impact a country's currency and inflation rate. Because of this, companies might struggle to raise salary increases as they might ideally want to.

What Happens If A Salary Does Not Increase With Inflation?

In an ideal world, every salary increase would match inflation compensation so that purchasing power is not negatively affected. If a salary does not increase with inflation, people might not be able to afford goods and services as well as expected. High and unexpected inflation rates can result in a decline in employees' purchasing power if their compensation does not increase with inflation. If their salary remains stagnant, it will be even more challenging as inflation rates increase over the years. When salary does not adequately increase with inflation, it may preclude even worse economic issues. Day-to-day expenses become higher and feel more difficult to afford. Inflation affects different industries differently and to various degrees. Employees may feel this inflation and salary increase mismatch when they buy necessities at the grocery store. Maybe they feel like they need to get paid more and that the prices at the store seem to be ever-increasing. There may even be a lack of adequate supply of the necessary things. Many powers are at play affecting the prices, but it is because of a far-reaching decline in purchasing power for the average consumer.

What Is Inflation?

Inflation is a rise in prices that occurs gradually. The increase in prices goes hand in hand with decreased purchasing power, which essentially means that a certain amount of money will no longer be able to afford something it once could before the inflation. Inflation is a percentage that serves as a single-value representation of how much the price level of goods and services has changed over time. Economists and central banks generally expect and prepare for moderate inflation, but unanticipated inflation can be a severe problem that sets off societal chain reactions.

What Causes Inflation?

Many factors combine to influence whether there is inflation and how much a currency inflates. Here are the most common causes of inflation:
  • Excess Demand. Demand that outpaces supply drives inflation.
  • Supply Shocks. Major crises and incidents can result in supply shocks. Common examples are warfare, which disrupts production and supply.
  • Money Supply Changes. If there is an increase in the money supply in an economy, people can purchase goods and services. However, if the supply of those goods and services has stayed the same, inflation may be the result.
  • Mounting Expectations and the Unexpected. A root cause in many inflation models, expectations push an economy toward higher inflation rates. Essentially, if supply and demand are in line with rising (or falling) at similar rates, expectations match up, and the economy should remain stable. However, if there's something unexpected, like a surge in demand, the supply won't be able to match.

How You Can Protect Yourself From Inflation

If You're An Employee, Negotiate A Higher Salary

Employee wages should tend to rise with inflation or in a recession. The first strategy is to negotiate a higher salary with your employer, which directly affects the increase in your paycheck. If you have concerns, a financial advisor can assist you in calculating the same raise that you should get so that you can counteract the effects of inflation.
#DidYouKnow You can also prepare yourself for a recession.

Invest In Stocks

To combat inflation, you may wish to invest in stocks if you are not already doing so. While the stock market is not always profitable and requires expertise in investments and stocks, long-term investments in stocks could be a good way to protect you against inflation. Finding a wealth advisor can help you immensely in this aspect.

Invest In Real Estate

A similar idea is to invest in real estate. In general, real estate investments are good financial assets. As for what's an asset, it is simply something that is of economic or financial value to you. You can convert it to cash when necessary.

Invest In International Bonds

Finally, another option to consider is to turn toward international bonds. Of course, while global investment options can help lower the risk and volatility of your portfolio, they can also expose you to other risks. National bonds have their support in the local currency, so they have national rules. Suppose you diversify your portfolio and enter the world of international bonds. Knowing other countries' rules and regulations and political and economic status is essential in that case. At the end of the day, it can be very challenging to protect yourself against unexpected inflation rates, especially if you live paycheck to paycheck. Sound financial best practices can assist you in being more resilient against economic fluctuations. Learn how to invest during a recession and tough times

FAQs

What is the average salary increase for 2023?

Adjusting salary for inflation for 2023 is 4.6% in the United States. The average salary increase in 2021 was 3.2%

Do wages increase with inflation?

Wages do increase with inflation, but wage growth may fail to match the pace of inflation. According to data from the Bureau of Labor Statistics, average hourly earnings for all workers have increased by about 2.4% per year since 1979 (when data on this metric first became available).

How much should my salary increase with inflation?

At least 4% in 2023. Your salary should increase enough, so your purchasing power can sustain it as much as possible. A financial advisor can help you determine the inflationary salary increase rate based on your career, industry, and other factors.

What is the correlation between inflation vs. salary increase?

Positive correlation. As the inflation rate increases, salary increases should go up too.

Should employers do inflation adjustment salary?

Yes. Ideally, employers should adjust salaries for inflation every single year.
 
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