Wage Growth vs. Inflation: Understanding the Dynamics

Should you ask for a raise? Many people ponder this question after working for the same company for several years. The thought behind asking for a raise is simple: You put in good work, have demonstrated your reliability, and want to get paid more. Some people opt against asking for raises because they don’t want to rock the boat. As long as they make the same money, they can continue to live their current lifestyle. Well, not quite. Inflation decreases your purchasing power each year. It also can outpace wage growth for people who do ask for raises. Understanding the dynamics of wage growth and inflation can help you make better decisions with your career and money management.

Understanding wage growth

Everyone’s wages grow at different rates based on their line of work, employer, performance, and other factors. While people have various levels of wage growth, the Occupational Employment and Wages Statistics (OEWS) program compiles wage data from approximately 830 occupations every year. This program is part of the U.S. Bureau of Labor Statistics and gives consumers a better idea of broad wage growth.

Higher wage growth gives consumers more money to spend. Having a $5,000 monthly payout turn into a $5,100 monthly payout increases your purchasing power. Higher demand for labor, fewer available workers, heightened productivity, and government policies are the key factors that contribute to wage growth.

Understanding inflation

Although wage growth empowers consumers, it also results in more money chasing fewer goods. Assume a movie theater can seat 100 people, and 150 people want to watch the movie. The movie theater can’t accommodate the extra 50 people, but the theater can raise ticket prices to increase profits and make crowds more manageable. Higher prices reduce demand, but some businesses can accept lower demand because of their limited supply of goods and the nature of profit margins.

If the cost of goods rises, companies will have to increase prices to offset costs. For instance, if the cost of producing an iPhone suddenly increases by 20%, Apple Inc. may raise the price of an iPhone by 20% to compensate for rising costs. 

You might feel like you’re getting ahead with a 4% raise, and getting a raise is better than not getting one at all. But if companies like Apple have to raise the price of their goods by 20%, like in the above example, are you really getting ahead of the curve? Inflation results in more expensive goods and services, and the rate of inflation can exceed the wage growth rate. This scenario results in consumers losing purchasing power.

Relationship between wage growth and inflation

Wage growth and inflation have a critical relationship that everyone should understand. 

1. The impact of inflation on wage growth

Rising inflation increases the pressure on workers to seek better opportunities and ask for raises. If inflation goes up by 4% in one year, it’s the equivalent of a 4% pay cut, even though you are working the same amount of hours. Incoming workers may also filter out career opportunities that do not post salaries that reflect higher inflation. Higher inflation leads to more wage growth, but that doesn’t necessarily mean higher real wage growth.

2. How inflation affects purchasing power

Inflation erodes purchasing power over time, and stashing money in the bank isn’t always a good long-term strategy. The U.S. dollar has lost 93% of its value since 1920, and high inflation can make that worse during certain years. If inflation goes up by 3%, your purchasing power goes down by 3%. Consumers may consider investing in stocks, real estate, and other assets in an effort to beat inflation. These assets allow people to not lose substantial purchasing power but also come with risks.  

3. Wage growth’s response to inflation

Higher inflation tends to prompt wage growth, but wage growth may not outperform the rate of inflation. Consumers can lose purchasing power even if they receive raises if the inflation rate exceeds the wage growth percentage. During inflation, many companies raise the prices of their goods and services and can use some of those proceeds to support higher wages.

Historical trend and example

While wage growth and inflation often move in tandem, inflation is often the leading indicator. Inflation data from January 2020 to June 2023 shows sharp inflation drops that take place before wages drop. While inflation drops lead to wage growth deceleration, inflation seems to drop at a faster rate. 

But during periods of rising inflation, the rate of inflation accelerated quicker than wage growth. Wage growth rates can remain stubborn at their levels unless a sharp rise or decrease in the rate of inflation continues for several months.

The changes in inflation and wage growth from May 2023 to June 2023 reflect this trend. During this time frame, inflation dropped from 4% to 3%, marking a 25% month-over-month drop. Wage growth dropped from 6% to 5.6% during the same time frame. That’s only a 6.7% month-over-month drop. 

While inflation can get a head start in either direction, wage growth eventually catches up or falls back in place with the rate of inflation.

Government policies and interventions

The government’s policies and interventions also play a role in wage growth and inflation. Governments can pressure companies to raise wages or set the minimum wage rate higher. Governments increase inflation every time they print more money. Every extra dollar added to circulation will increase inflation.

Removing money from the system through methods like raising interest rates can contribute to deflation. The Federal Reserve has been raising interest rates since 2022 in response to high inflation. Last month, the Fed raised interest rates for the 11th time in 17 months to combat inflation. The Fed hopes to bring inflation back down to 2%.

How can you protect yourself from the negative impact of inflation on wages?

Although inflation reduces purchasing power, consumers have several ways to protect their  finances from a rising inflation rate.

1. Invest in assets that appreciate with inflation 

Assets like real estate and gold tend to appreciate when inflation increases. Because real estate and gold have limited quantities and remain in demand, they may gain value as inflation rises.

2. Negotiate for higher wages

Receiving a raise, no matter the size, will help with inflation. Wage growth makes inflation more manageable, but you should aim for wage growth that exceeds the rate of inflation to increase your purchasing power.

3. Keep your skills up to date

Developing new skills can give you more career opportunities and can help you get paid more money for the same amount of hours. You can look for high-paying skills and add them to your toolbox by reading books, watching videos, and applying what you learn.

4. Budget wisely

A budget helps you maximize your money. Listing your expenses and removing the nonessentials gives you more money to build your savings and investment accounts. 

If an emergency expense comes up, you can use Instacash^SM to get a cash advance of up to $500 at 0% annual percentage rate (APR)*. This choice can help you avoid loans and racking up credit card debt. 

Increasing your purchasing power

Real wages reflect wage growth and the rate of inflation to gauge how much people’s wages have gained relative to purchasing power. While broad statistics reveal what is happening in the economy, you can increase your purchasing power by getting a bigger raise, pursuing better career opportunities, and exploring side hustles. Consumers should look at changes to their purchasing power and real wages instead of nominal wage growth.

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