Compensation and Inflation: Breaking it Down

Back in the day when I first started doing compensation work, my more experienced peers spoke of a time when there were double digit merit increases. I couldn’t imagine such a thing! And now here we are, maybe not quite at the levels of the past, but higher than in recent years.

For employees, higher raises must be a huge plus, right? Well, kind of. Since the rate of inflation has increased faster than wages, a higher salary doesn’t necessarily translate to increased buying power.

According to the Bureau of Labor Statistics, inflation has increased by 9.1% year-over-year as of June 2022. This is the largest 12-month increase since the period ending November 1981.

Inflation's Impact on Salary Budgets

To understand the impact of the current economic environment on salary budgets, it is important to understand terms related to labor and inflation.

• Salary Increase Budget – The pool of money an organization pays to increase base salaries, typically including promotions, merit increases and cost-of-living adjustments.
• Inflation – Typically defined as an annual change in prices for goods and services.
• Cost of Labor – The cost which reflects the external labor market’s pay practices for total compensation based on all jobs combined for a geographic location.
• Cost of Living – The cost to maintain a certain standard of living within a geographic location (based on goods and services). 

While the cost of labor and inflation often directionally correlate, they are not exact. Over much of the past decade, salary increases have exceeded inflation increases. Inflation is also a more volatile measure than cost of labor.

Compensation Communication & Transparency

Obviously, there are a lot of components to understanding compensation in today’s environment. As you communicate and explain to employees how inflation impacts compensation, remember to:

• Be Transparent – employees who know how their pay is determined can better understand all the aspects considered through the process. Explain how inflation plays a part.
• Provide Data – a conversation is the best way to communicate employee-specific compensation information and providing data to support the verbal exchange reinforces the message.
• Follow Up – be proactive and ensure open lines of communication to address future changes.

With continued economic shifts on the horizon, it is important to show your employees how you plan to address compensation.

Employees are often looking for workplaces that provide a strong sense of pay transparency and commit to addressing any existing pay gaps. Make that your workplace!