How Inflation Impacts Compensation Levels

By Christie Summervill

How Inflation Impacts Compensation Levels

Inflation is the rate of increase in prices over a given period and is typically a broad measure that includes the overall rise in prices or the increase in the cost of living in a country.

Inflation represents how much more expensive the relevant set of goods and/or services has become over a year. Looking at salary ranges in light of current inflation rates, is it the responsibility of employers to make up for lower purchasing power?

The Federal Reserve defines a “healthy inflation rate” as 2.0% for the US economy annually. Currently, the consumer price inflation is at 6.25% and is projected to rise to 8.0% this year. As Fox Business reports, “consumer prices surged at the fastest pace in nearly four decades in November as Americans paid more for practically everything from groceries to cars to gasoline, solidifying hot inflation as a key trait of the economic recovery.” Central bankers believe that inflation will decline to 2.5% by Q4; however, Christie Summervill, CEO of BalancedComp, a consultancy for banks and credit unions, warns of an unrelenting, not ‘transitory,’ increase in inflation, given that once inflation takes hold, it is challenging to curtail. Summervill adds, “I remain concerned that clients put themselves in a position of being behind the curve if they’re wrong.” 

When inflation rises, the purchasing power of compensation does fall, but is it the responsibility of employers to shore this up with higher salaries? This is a tricky question. Some non-profit institutions, like credit unions, may express their cultural values in a way that leads the board to the conclusion to do so. Aside from the philosophical question of whether employers should compensate for inflation, the fundamental need to attract and retain talent to continue to succeed in business is causing many employers to question their strategy. This creates unnecessary friction between employee expectations and employers’ paying power. According to Christie Summervill, “‘While compensation budgets may not rise to the level of employee expectations, they’re the highest we’ve seen since the 2008 financial crisis. The projected 3.0% labor budgets created in August and September have largely increased to 4.0% in response to the Great Resignation.” 

For financial institutions, higher inflation is generally seen as neutral and, sometimes, as a positive as it can increase net interest income from rising interest rates and boost profitability. This must be balanced with an increase in the cost of funds and a decrease in consumer demands for loans, which can reduce profits. Overall, inflation is seen to have a negative correlation with the profitability of financial institutions, which means that if one variable increases, the other variable decreases. Therefore, the need to consider increases in salaries is more impacted by the supply and demand of employees than it is a social or moral obligation to increase employee purchasing power caused by inflation. 

However, when you combine the declined value of the dollar with the labor shortages the US is currently experiencing, it’s clear that employees’ expectations around compensation are rising. Employees’ confidence level in their ability to replace their current compensation level and make even more is at an all-time high. Additionally, when competition is willing to pay higher dollars to get needed talent in place, you will likely end up paying a new hire more than a current employee who is looking for a new job. According to a recent article from USAToday, “46% of executives said higher pay for new employees was a reason for the larger pay pools that are expected, while 39% said inflation helped fuel the increase.” Some questions to ask yourself may include: Why are those who are not looking for employment elsewhere staying? Is it your culture? Is it your compensation model? Is it your corporate leadership? If so, how can you enhance those aspects? A well-conducted “stay” interview with a current employee could reveal more information and possible answers to these questions. 

If you feel confident that inflation will return to normal levels over the next few months, you may consider giving employees mid-year bonuses versus salary increases to tide over your staff until things stabilize. Perhaps you could consider giving this to only nonexempt employees, as getting by on 94% purchasing power more significantly impacts an employee who is paid $30,000 than someone making a salary of $150,000. On the other hand, if you believe that inflation is here to stay through 2022 and beyond, increasing employee wages for the long term might feel like the better solution.

“Our clients’ reactions are all across the board,” shared Summervill. “One client in the northwest added a bonus equal to $5 per hour for all essential workers that were member-facing in 2020 and are now trying to make that permanent. Another client can only get a 2.8% labor budget increase. Many, if not most, are increasing their lowest starting wage. Hopefully, they consider the wage compression issues, as well.” 

In the long run, employees are paid for what they contribute to the organization. If demand for labor remains high and supply growth is sluggish, we would expect organizations to feel the pressure to increase compensation to attract the employees they need. That said, the average 4.0% labor budget does not keep pace with the current and forecasted 6.25% – 8.00% inflation rate for 2022. Focusing on the salaries of high performers and those in “hot job” positions—or jobs with the highest impact if they were vacated—is a must. Lastly, focusing on your culture and management engagement strategy to avoid employees feeling compelled to look for other jobs will remain a top priority.

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