Inflation and Merit Increases for 2023 Compensation Planning

Written by: Vicki Shepard

October 23, 2022

3 min read

Inflation has risen dramatically in the past year and has been reported to be over 8.3% at the end of August 2022. Many of your employees may be asking you if that means they’ll also be receiving an 8% increase. The short answer is no. It’s important to understand that inflation and wage growth are not one and the same. In fact, wage growth has historically out-paced inflation and we are simply in the reverse situation today.

So, what is inflation?

In economics, inflation is a general increase in the prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. Simply, inflation is the rate at which prices for goods and services increase. When prices of goods and services rise, that means that one unit of money will buy fewer goods and services than previously. This is called a loss of purchasing power, which can also impact the cost of living (however this is different from geographic differential). The consensus view among economists is that sustained inflation occurs when a nation’s money supply growth outpaces economic growth.

So, what is wage growth?

Wage growth is a rise of wages adjusted for inflation. In macroeconomics, wage growth is one of the main indications to measure economic growth for a long term, since is reflects the consumer’s purchasing power in the economy as well as the level of living standards.

How does inflation impact wage-growth?

As we continue to emerge out of the pandemic, we are still recovering from supply chain disruptions1 and the current war in the Ukraine2. And in conjunction with these challenges, the United States currently has a tight labor market and considerably low unemployment rate. With this unique environment, it is expected wage growth to also increase with inflation expectations being felt over a longer period of time and remaining elevated. These pressures are felt across every organization.

Tying it all together with 2023 Compensation Planning

Although merit increase budgets are increasing beyond levels in recent years and employees may be receiving larger increases than in previous years, it will not be at the same rate of inflation. Many organizations have simply tried to help employees understand the difference between wage growth and inflation, while others have opted to provide a nominal (most commonly 3%) increase or bonus as a gesture of goodwill to employees struggling with the consequences of inflation.