The annual performance review is something everyone dreads. Even HR people hate them yet we all have to do one and the ONLY reason we do them is because there is a possibility of a raise at the end of it. Try to remember all your achievements at work the past year and hurry through filling out the form to receive a 2.5% raise. 2.5%! That equates to about $104 more a month for someone making $50,000 a year. That’s not enough for anyone to change their lifestyle and spend more money which is what is supposed to happen when an economy is booming. In fact, that $104 or 2.5% increase in wages is being eaten away by an evil bastard economists refer to as inflation.
What is inflation?
Inflation is the increase in price of a good or service which reduces the purchasing power of money.
For a non-economic jargon example let’s say the price of milk was $3.50 a gallon last year and it is $4.00 this year. It could be said that the price of milk increased $0.50 per gallon or there was 14% inflation. In this example, the same amount of milk costs more money today so the amount of milk you can buy for $1 has been reduced.
How is inflation measured?
There are many ways that inflation is measured in the market. Economists try to track inflation on pretty much everything. One of the most common measures of inflation is the Consumer Price Index or CPI.
The latest CPI report from January indicated year-over-year inflation was up 2.5%. The CPI report assigns a specific weighting to the various goods and services they track to come up with a basket of goods to determine the overall inflation level.
Some goods actually decreased in price such as pork chops (down 5.5%) and chicken (down 1.2%). If you are a meat lover, eat up! On the other hand the price of gasoline for regular unleaded is up 21% since last year. Even though I eat a lot of chicken, I still spend more on gasoline each month so the increase in gasoline prices is costing me considerably more than I am saving on chicken and pork chops.
Most of us spend a good portion of our income on basic needs such as housing, food, clothing, transportation, healthcare and insurance. This is what the CPI is supposed to track.
If inflation is at 2.5% that means you need your income to increase MORE than 2.5% or else your purchasing power has effectively decreased. Those same goods and services you bought last year now take up more of your income.
How much are wages increasing?
Just as inflation is tracked a variety of ways so are wages. One method is through average weekly earnings which has increased on average about 2.3% for the past 5 years.
The chart below shows the rate of increase in average weekly earnings. This is a volatile number but has remained between 1.5% and 2.5% for the most part.
Real wage growth measures the effect of inflation
Finally, to understand the effect inflation has on wages, we use the term “real” to describe wage growth. Real wage growth takes the increase in wages and subtracts inflation. This tells us how much, in real terms, the average weekly earnings is increasing.
The real average weekly earnings chart is below.
Incredibly, wages are currently decreasing at a rate of .63% when including the effects of inflation. A worker making $50,000 a year might have received a 2.5% increase in pay but since inflation was also 2.5% they are not making any more money in real terms because they are spending 2.5% more on goods and services.
This is not supposed to be happening since the unemployment rate is so low and the economy is supposed to be well into a recovery. With fewer unemployed workers it should cost employers more to find new workers and wages should be going up. Workers should also be demanding higher wages to offset the increase in inflation.
Don’t settle for 2.5%
Workers have to find a way to increase their earnings more than the rate of inflation. This might mean finding a new employer, changing careers, or seeking a promotion with the current employer. This is the only way to really grow your income since the annual salary review is not likely going to lead to long-term prosperity.
There are two things we all want more of: money and time. I keep telling myself I need to earn more money this year because each year that passes is one less year I’m able to earn money and save it. Hopefully, this article at least brought to your attention the effect inflation can have on your income and will help motivate you to earn more!