Why Don’t Salary Increases and Inflation Move in Tandem?

Many employees closed out 2022 questioning why their merit increases were not rising to the same level as the increased costs of their goods and services. Now, 2023 has given way to some relief as inflation is trending back down, but the projected average salary increase has ticked up to 4.6% – higher than the 2022 projected and actual averages increases, according to a WTW article. Several explanations are cited for why wages and inflation do not move at the same pace.

• Different inputs drive the numbers. Pay is largely determined by the supply and demand for labor, which is influenced by local demographics and unemployment rates, whereas inflation is driven primarily by increased costs in daily living expenses like home, food, and automobile costs. “Independent of inflation, pay increases generally are expected to remain high as long as unemployment remains low.” 
  
  
• Salary budgets are only one slice of the total rewards expense. Salary increase numbers are not inclusive of significant employer benefit costs – like health care and retirement – that have grown in recent years at rates above the inflation level. These costs are included in economic wage data and impact inflation but are often not considered by employees solely focused on their paycheck. 
  
  
• Pay levels rarely go down. Employers are careful not to react too quickly to market conditions by increasing salaries across the board when talent markets are tight, because payrates are “sticky” and do not get reduced in tough economic times and throughout business cycles. 
  
  
• Data lags. Both inflation and pay data lag current market conditions, so it is difficult to understand how they interact in current times, as seen during the pandemic. Pay increased primarily to attract new entry level workers in industries that were booming despite significant layoffs in other industries. Understanding the role inflation plays in this labor market can be grey with the lagged timing.

A PayScale article also attempts to explain the relationship between pay and inflation. It highlights the wage growth index which tracks changes in total cash compensation on a quarterly basis for full time, private sector companies across the country. The data reveals that national wage growth has increased 7.5% year over year as of April. The index also accounts for “real wages” that factor in inflation through CPI data to understand purchasing power. This data shows wages have fallen 1.3% year over year.